For an A rated corporate bond with deteriorating fundementals, the greatest risk is Event risk default risk liquidity risk credit spread risk Can somebody explain - credit risk, credit spread risk and default risk and their relationship please? Thanks S
default, then credit spread gotta go eat will let someone else explain lol
Event risk = risk of some unforseen event or announcement. irrelevant for this Q Default risk = risk that company will be unable to meet commitments under the indenture – most notably, paying coupon and principal but also includes technical default under covenants. Most relevant in this case as the company’s performance is declining. Liquidity risk = also a concern with a declining company, as fewer people will want to buy it unless it’s at a good price… so, lesser issue. Credit spread risk = more of a macro concept in which the yield curve spread on all risky credits increases compared to the risk-free asset because general economic conditions are seen as deteriorating an all corporates are viewed as riskier.
mcf Wrote: ------------------------------------------------------- > Event risk = risk of some unforseen event or > announcement. irrelevant for this Q > > Default risk = risk that company will be unable to > meet commitments under the indenture – most > notably, paying coupon and principal but also > includes technical default under covenants. Most > relevant in this case as the company’s performance > is declining. > > Liquidity risk = also a concern with a declining > company, as fewer people will want to buy it > unless it’s at a good price… so, lesser issue. > > Credit spread risk = more of a macro concept in > which the yield curve spread on all risky credits > increases compared to the risk-free asset because > general economic conditions are seen as > deteriorating an all corporates are viewed as > riskier. Are these collectively called credit risk? S
No. Although default risk and credit spread risk are primarily keyed to credit concerns with a company.
Downgrade risk, credit spread risk, and default risk are collectively called credit risk.
Credit risk is indeed an umbrella kind of risk that means that there is some probability that someone who owes you money won’t pay you back. I like mcf’s definitions above except that I bet the answer to this question is credit spread risk (I would call it downgrade risk). A-rated companies usually don’t default very soon (I know, Worldcom) so default is probably not the issue. The risk is that deteriorating financials cause a downgrade in its rating, possibly even to junk status. I’ll bet that the person who wrote the question calls that credit spread risk, though I like mcf’s def better.
If a bond is downgraded, are the only negative effects a decrease in price?
That’s a pretty important negative effect. If a bond is downgraded, there might be a bunch of people who have to sell it because they have rules forbidding them from owning, say, anything below BBB. There is a tradition in Japanese firms that CEO’s of downgraded firms have to cut off a finger for each notch of downgrade. No such American custom I know of.
what happens if you run out of fingers…“shudders”
Ever read that novella Patriotism by Mishima?
JoeyDVivre Wrote: ------------------------------------------------------- > That’s a pretty important negative effect. If a > bond is downgraded, there might be a bunch of > people who have to sell it because they have rules > forbidding them from owning, say, anything below > BBB. > > There is a tradition in Japanese firms that CEO’s > of downgraded firms have to cut off a finger for > each notch of downgrade. No such American custom > I know of. That is why the CEO of Rescap doesnt have any finger left 
I think there are some people at Cerberus who need to lose fingers. What rating did ResCap have a few years ago?
JoeyDVivre Wrote: ------------------------------------------------------- > I think there are some people at Cerberus who need > to lose fingers. What rating did ResCap have a > few years ago? BBB- in 2005 I think…this clearly shows bad bad bad management