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IAI Actuarial Core Principles · Economic Modelling · Simple models for credit risk

A bond issuer is rated by an agency. Which statement best describes the credit risk of a zero-coupon bond held to maturity?

Credit risk on a zero-coupon bond is the risk that the issuer fails to pay the promised redemption amount in full and on time. Interest rate, inflation and liquidity risks are different risks and do not describe default by the borrower.

  1. AIt is the risk that the issuer fails to pay the promised redemption amount in full on timeCorrect
  2. BIt is the risk that market interest rates change before maturity
  3. CIt is the risk that inflation erodes the real value of the redemption payment
  4. DIt is the risk that the bond cannot be sold quickly at fair value
  5. It is the risk that the investor's utility function changes

Explanation

Credit (default) risk is the risk that the counterparty does not meet its contractual payment obligations in full and on time. Interest rate, inflation and liquidity risk are distinct risks and do not define credit risk.

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