Financial Risk Manager Part 1

Explanation

Default risk is a form of credit risk. It refers to the risk that a borrower will not be able to meet scheduled repayments of interest or principal on a debt obligation. This is the most direct form of credit risk. In such a case, the lender or investor may lose the principal and interest, disrupt cash flows, and increase the cost of collection. Default risk is a significant factor in determining the interest rate on a loan or on a bond.

Why other options are incorrect:

• A. Commodity price risk: This is a form of market risk, not credit risk. It refers to the uncertainty stemming from changes in the price of a commodity.

• B. Currency exchange risk: Also known as foreign exchange risk, this is a market risk posed by an exposure to unanticipated changes in the exchange rate between two currencies. Businesses that operate internationally often face currency exchange risk.

• C. Interest rate risk: This is the risk that an investment's value will change due to a change in the absolute level of interest rates, the spread between two rates, or the shape of the yield curve. While this risk can impact the value of fixed-income investments (like bonds) and therefore indirectly impact a borrower's ability to repay debt, it is considered a type of market risk rather than a form of credit risk.