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.

A is incorrect. 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 is incorrect. Equity price risk is the risk that is associated with volatility in stock prices. It doesn't result in an increase in the cost of debt.

C is incorrect. 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.

Things to Remember

• Downgrade risk impacts the cost of debt by affecting interest rates applied to new and possibly existing debts.
• Monitoring credit ratings is crucial for financial analysts to preemptively manage the financial strategies around potential downgrades.
• Regular assessments by credit agencies such as Standard & Poor's, Moody's, and Fitch play a significant role in credit risk management.