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

In a simple credit risk model, which of the following correctly describes credit risk?

Credit risk is the risk that a borrower or counterparty does not pay its contractual obligations in full and on time. Interest rate, liquidity, inflation and early redemption risks are different risks and do not describe default or failure to pay.

  1. AThe risk that market interest rates move against a bond holder
  2. BThe risk that a counterparty fails to meet its contractual payment obligations in full and on timeCorrect
  3. CThe risk that a security cannot be sold quickly without a price concession
  4. DThe risk that inflation erodes the real value of coupons
  5. The risk that a bond is redeemed before its stated maturity date

Explanation

Credit risk is the risk of loss arising because a counterparty defaults or fails to pay as contractually due. The other options describe interest rate risk, liquidity risk, inflation risk and call risk respectively.

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