Credit Risk

What credit risk is and where it comes from, how expected loss splits into probability of default and loss given default, what credit ratings can and cannot tell you, which macroeconomic, market and issuer-specific forces move yield spreads, and how a spread change feeds through to a bond's price via duration and convexity.

1. 1. Credit risk and where it comes fromCredit risk is the chance of losing money because a borrower does not pay interest and principal in full and on time, and it starts with where the borrower's cash comes from.Free12 min
2. 2. Expected loss: POD × LGDExpected loss is the probability that a borrower defaults times how much you lose if it does, and a fairly priced credit spread should at least cover it.Video · 6 min14 min
3. 3. What drives default risk and recoveryThe probability of default is driven by profitability, coverage and leverage, while the loss given default depends mostly on where your claim ranks and what backs it.12 min
4. 4. Credit ratings: uses and limitsCredit ratings are a quick, symbol-based ranking of default risk that markets rely on heavily, but they lag prices, miss some risks and can simply be wrong.14 min
5. 5. Why spreads move: macro and issuer factorsYield spreads widen when the credit cycle turns down, when markets fear risk or lack funding, and when a specific issuer's coverage or leverage deteriorates; high-yield spreads move the most.13 min
6. 6. Inside the spread: credit and liquidityA corporate bond's yield is a government benchmark yield plus a spread, and that spread pays for credit risk, market liquidity risk and possibly taxes; the liquidity part can be measured from bid and offer yields.12 min
7. 7. How spread changes move bond pricesA change in spread moves a bond's price exactly like any other yield change: about minus modified duration times the spread change, plus a convexity correction for large moves.Video · 6 min15 min
8. 8. Integrated cases: reading a corporate quoteOne quote sheet answers three questions in order: what yield spread does the bond pay, how much of it is liquidity rather than credit, and how far could the spread widen before the price falls by a given amount.16 min