- CFA Exams
- 2024 Level II
- Topic 6. Fixed Income
- Learning Module 47. Fundamentals of Credit Analysis
- Subject 1. Credit Risk
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Subject 1. Credit Risk PDF Download
Credit risk is the risk of loss of interest and/or principal stemming from a borrower's failure to repay a loan.
Credit risk has two components:
The spread refers to the difference between the yield on a specific bond and a comparable maturity (or duration) Treasury. The part of the risk premium representing the default risk is known as the credit spread. If the perception of risk increases for the issuer or for the industry category representing the issuer, the spread may increase or widen. This risk associated with an increasing credit spread is known as the credit spread risk. If there are more concerns about economic security, the spread will widen (implying that the premium for risk increases).
Credit risk could be on account of:
User Contributed Comments 9
|Smarty11||yields DO NOT necessarily decline in anticipation of a downgrade... Spread widening is a funtion of downgrade. Yields, however, are complicated to analyze. They drive up and down based on economic factors - such as inflation.|
|snider||are you sure?! when we do analysis we should assume other factors being constant. if there is a downgrade ahead surely the yield will decline.|
|mattl31||price will decline, yield will increase|
|mysking||isn't yield has been pre-fixed?|
|siuhunghung||If spread widen, there are more risk then obviously yield has to go up to compensate for the extra risk.|
|bmeisner||Ok being a corporate bond trader I can clue you guys in on how it actually works. 1. Spreads are always calcuated off LIBOR/IRswaps, not off treasuries, especially in the environment after the credit melt down because even the spread between LIBOR/IRswaps and T-bills has widened significantly because bank credit risk has increased. 2. Ratings downgrades are usually a lagging indicator these days, not leading. The only case when they are relevant is when a corporate goes from an investment grade rating to a specualtive rating (for S&P the lowest investment grade rating is BBB-). The reason why this matters is because a lot of insurance companies and investment funds are only allowed to hold investment grade corporate debt by the funds' original mandate.|
|thalor||So downgrade risk only matters at the edge of investment-grade versus junk? As in, institutional investors don't do their own credit rating assessments?|
|Seemorr||At least in municipal bonds, ratings matter a lot, and spreads are almost always calculated versus Treasuries.|
|johntan1979||From previous modules:
Credit risk includes
1. Default risk
2. Credit spread risk
3. Downgrade risk
I am happy to say that I passed! Your study notes certainly helped prepare me for what was the most difficult exam I had ever taken.
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