Default risk is the risk that a borrower will fail to make the required payments on a debt obligation, such as a loan, bond, or credit card. It represents the probability that the borrower will not fulfill the scheduled interest or principal payments, resulting in a potential loss for the lender or investor. Default risk affects virtually all credit offerings, and borrowers with higher default risk generally pay higher interest rates to compensate the lender for this risk.

Key Points About Default Risk

• It applies to both individuals and companies.
• It is influenced by the borrower's financial capacity and broader economic conditions.
• It is measured by credit scoring for individuals and credit rating agencies for companies and governments.
• The higher the default risk, the higher the interest rate or return demanded by lenders or investors.
• Understanding default risk is crucial for lenders, investors, and anyone involved in credit transactions.

How Default Risk Is Assessed

• Borrower's financial health, including income, assets, liabilities, and credit history.
• Economic factors like GDP growth, unemployment, inflation, and interest rates.
• Debt structure, including interest rates, repayment terms, and collateral.
• Evaluation by credit rating agencies such as Moody's, S&P, and Fitch.

In summary, default risk is the chance a borrower may not meet their debt payment obligations, which is a fundamental consideration in lending and investment decisions.