Explanation:

Loss severity (also known as loss given default or LGD) refers to the portion of a bond's value that an investor loses when a default occurs. It represents the actual financial loss experienced by the investor after accounting for any recovery value.

Why other options are incorrect:

• A. Default risk: This refers to the probability or likelihood that a borrower will default on their debt obligations, not the actual loss amount.

• C. Expected loss: This is a broader concept that combines both the probability of default (default risk) and the loss severity. Expected loss = Probability of Default × Loss Given Default. It represents the average loss expected over time, not the specific portion lost in a default event.

Key Distinction:

• Loss severity = How much you lose WHEN default happens
• Default risk = How LIKELY default is to happen
• Expected loss = Probability × Severity (the statistical expectation)

In fixed income analysis, understanding loss severity is crucial for assessing credit risk and pricing bonds appropriately.