Financial Risk Manager Part 1
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A financial analyst is analyzing a bank's financial health and is particularly worried about the potential increase in the bank's cost of debt due to a possible decline in its credit rating. This concern is associated with which type of risk among the following options?
Other
Community
TTanishq
A
Interest Rate Risk
B
Equity Price Risk
C
Bankruptcy Risk
D
Downgrade Risk
Explanation:
Explanation
Downgrade risk is an example of credit risk. It refers to the potential for a company's credit rating to be lowered by credit rating agencies, such as Standard & Poor's, Moody's, and Fitch Ratings. Credit ratings are an assessment of a company's creditworthiness and its ability to meet financial obligations, such as debt payments. A downgrade indicates that the credit rating agency perceives an increased risk of default or financial distress for the company.
Why other options are incorrect:
- A. Interest Rate Risk: Arises from fluctuations in the market interest rates, and it may cause a decline in the value of interest-rate-sensitive portfolios.
- B. Equity Price Risk: Is the risk associated with volatility in stock prices. It doesn't result in an increase in the cost of debt.
- C. Bankruptcy Risk: Is another example of credit risk. It is associated with a borrower's inability to clear his debt leading to a takeover of his collateralized assets.
When a bank's credit rating is downgraded, it typically faces higher borrowing costs as lenders demand higher interest rates to compensate for the perceived increased risk of default.
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