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Credit Risk

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Definition of Credit Risk

Credit Risk Image 1

Credit Risk

Financial and moral risk that an obligation will not be paid and a loss will result.


Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the
payment may not be made on a negotiable instrument. Related: Default risk



Related Terms:

Current coupon

A bond selling at or close to par, that is, a bond with a coupon close to the yields currently
offered on new bonds of a similar maturity and credit risk.


Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.


Accidental Dismemberment: (Credit Insurance)

Provides additional financial security should an insured person be dismembered or lose the use of a limb as the result of an accident.


Amortization (Credit Insurance)

Refers to the reduction of debt by regular payments of interest and principal in order to pay off a loan by maturity.



Asset-specific Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as company-specific risk or
unsystematic risk.


Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.


Credit Risk Image 2

Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.


Beneficiary (Credit Insurance)

The person or party designated to receive proceeds entitled by a benefit. Payment of a benefit is triggered by an event. In the case of credit insurance, the beneficiary will always be the creditor.


Best-interests-of-creditors test

The requirement that a claim holder voting against a plan of reorganization
must receive at least as much as he would have if the debtor were liquidated.


Beta risk

risk of a firm measured from the standpoint of an investor who holds a highly diversified portfolio.


Borrower (Credit Insurance)

A consumer who borrows money from a lender.


Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.


Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.


Commercial Business Loan (Credit Insurance)

An agreement between a creditor and a borrower, where the creditor has loaned an amount to the borrower for business purposes.


Commercial risk

The risk that a foreign debtor will be unable to pay its debts because of business events,
such as bankruptcy.


Credit Risk Image 3

Company-specific risk

Related: Unsystematic risk


Companyspecific Risk

See asset-specific risk



Comparative credit analysis

A method of analysis in which a firm is compared to others that have a desired
target debt rating in order to infer an appropriate financial ratio target.


Completion risk

The risk that a project will not be brought into operation successfully.


Consumer credit

credit granted by a firm to consumers for the purchase of goods or services. Also called
retail credit.


Consumer Credit Protection Act

A federal Act specifying the proportion of
total pay that may be garnished.


Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.


Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.


Country risk General

Level of political and economic uncertainty in a country affecting the value of loans or
investments in that country.


Credit

Money loaned.


Credit

Buying or selling goods or services now with the intention of payment following at some time in
the future (as opposed to buying or selling goods or services for cash).


Credit Risk Image 4

Credit

One side of a journal entry, usually depicted as the right side.



Credit

A rating of a company's credit (ability to payback debt), usually by a third party credit agency.


credit

On your bank statement, 'credit' represents funds that you have deposited into your account. The opposite of a credit is a debit.
However, ‘credit’ also means money that you borrow from a financial lender, like a bank. A credit card, for example, is a card that allows you to access funds which you then have to repay.


Credit analysis

The process of analyzing information on companies and bond issues in order to estimate the
ability of the issuer to live up to its future contractual obligations. Related: default risk


credit analysis

Procedure to determine the likelihood a customer will pay its bills.


credit bureau

An organization that provides financial institutions with credit information concerning existing or potential customers who are looking to obtain credit services.


credit card

A revolving source of credit with a pre-established limit. You have to pay interest on a credit card if you have an outstanding balance.


Credit Crunch

A decline in the ability or willingness of banks to lend.


Credit enhancement

Purchase of the financial guarantee of a large insurance company to raise funds.


Credit Loss

A loan receivable that has proven uncollectible and is written off.


credit memo

A record of the funds which have been credited to your account.


Credit period

The length of time for which the customer is granted credit.


credit policy

Standards set to determine the amount and nature of credit to extend to customers.


Credit Rationing

Restriction of loans by lenders so that not all borrowers willing to pay the current interest rate are able to obtain loans.


Credit scoring

A statistical technique wherein several financial characteristics are combined to form a single
score to represent a customer's creditworthiness.


Credit spread

Related:Quality spread


Credit Terms

Conditions under which credit is extended by a lender to a borrower.


Credit Union

credit unions are community based financial co-operatives and most offer a full range of services. All are owned and controlled by members who are also shareholders. credit unions are regulated provincially and insured by a stabilization fund, deposit insurance or guarantee corporation.
credit unions are supported by a system of provincial credit union Centrals, a national credit union Central and affiliated national financial co-operatives.


Crediting rate

The interest rate offered on an investment type insurance policy.


Creditor

Lender of money.


Creditor

Person or business that is owed money.


Creditor (Credit Insurance)

A lender or lending institution that offers financing and loans to a borrower, for the purpose of acquiring a commodity.


Creditor Proof Protection

The creditor proof status of such things as life insurance, non-registered life insurance investments, life insurance RRSPs and life insurance RRIFs make these attractive products for high net worth individuals, professionals and business owners who may have creditor concerns. Under most circumstances the creditor proof rules of the different provincial insurance acts take priority over the federal bankruptcy rules.
The provincial insurance acts protect life insurance products which have a family class beneficiary. Family class beneficiaries include the spouse, parent, child or grandchild of the life insured, except in Quebec, where creditor protection rules apply to spouse, ascendants and descendants of the insured. Investments sold by other financial institutions do not offer the same security should the holder go bankrupt. There are also circumstances under which the creditor proof protections do not hold for life insurance products. Federal bankruptcy law disallows the protection for any transfers made within one year of bankruptcy. In addition, should it be found that a person shifted money to an insurance company fund in bad faith for the specific purpose of avoiding creditors, these funds will not be creditor proof.


Creditors

Purchases of goods or services from suppliers on credit to whom the debt is not yet paid. Or a
term used in the Balance Sheet to denote current liabilities.


Critical Illness Insurance (Credit Insurance)

Coverage that provides a lump-sum payment should you become seriously ill with a specified illness. The payment is made to your creditors to pay off your debt owing.


Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.


Currency risk

Related: Exchange rate risk


Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying
transaction.


Debt (Credit Insurance)

Money, goods or services that someone is obligated to pay someone else in accordance with an expressed or implied agreement. Debt may or may not be secured.


Demand line of credit

A bank line of credit that enables a customer to borrow on a daily or on-demand basis.


Disability Insurance (Credit Insurance)

Group Insurance designed to cover monthly obligations due to a borrower being unable to work due to sickness or injury.


Diversifiable risk

Related: unsystematic risk.


Economic risk

In project financing, the risk that the project's output will not be salable at a price that will
cover the project's operating and maintenance costs and its debt service requirements.


Equilibrium market price of risk

The slope of the capital market line (CML). Since the CML represents the
return offered to compensate for a perceived level of risk, each point on the line is a balanced market
condition, or equilibrium. The slope of the line determines the additional return needed to compensate for a
unit change in risk.


Eurocredits

Intermediate-term loans of Eurocurrencies made by banking syndicates to corporate and
government borrowers.


Event risk

The risk that the ability of an issuer to make interest and principal payments will change because
of rare, discontinuous, and very large, unanticipated changes in the market environment such as (1) a natural
or industrial accident or some regulatory change or (2) a takeover or corporate restructuring.


Evergreen credit

Revolving credit without maturity.


Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.


Exchange risk

The variability of a firm's value that results from unexpected exchange rate changes or the
extent to which the present value of a firm is expected to change as a result of a given currency's appreciation
or depreciation.


Export Credit Insurance

The granting of insurance to cover the commercial and political risks of selling in foreign markets.


Fallout risk

A type of mortgage pipeline risk that is generally created when the terms of the loan to be
originated are set at the same time as the sale terms are set. The risk is that either of the two parties, borrower
or investor, fails to close and the loan "falls out" of the pipeline.


Federal credit agencies

Agencies of the federal government set up to supply credit to various classes of
institutions and individuals, e.g. S&Ls, small business firms, students, farmers, and exporters.


Financial risk

The risk that the cash flow of an issuer will not be adequate to meet its financial obligations.
Also referred to as the additional risk that a firm's stockholder bears when the firm utilizes debt and equity.


financial risk

risk to shareholders resulting from the use of debt.


Firm-specific risk

See:diversifiable risk or unsystematic risk.


Five Cs of credit

Five characteristics that are used to form a judgement about a customer's creditworthiness:
character, capacity, capital, collateral, and conditions.


Flat price risk

Taking a position either long or short that does not involve spreading.


Force majeure risk

The risk that there will be an interruption of operations for a prolonged period after a
project finance project has been completed due to fire, flood, storm, or some other factor beyond the control
of the project's sponsors.


Foreign exchange risk

The risk that a long or short position in a foreign currency might have to be closed out
at a loss due to an adverse movement in the currency rates.


Foreign tax credit

Home country credit against domestic income tax for foreign taxes paid on foreign
derived earnings.


Formalized Line of Credit

A contractual commitment to make loans to a particular borrower up to a specified maximum during a specified period, usually one year.


Full Credit Period

The period of trade credit given by a supplier to its customer.


Full faith-and-credit obligations

The security pledges for larger municipal bond issuers, such as states and
large cities which have diverse funding sources.


Funding risk

Related: interest rate risk


Geographic risk

risk that arises when an issuer has policies concentrated within certain geographic areas,
such as the risk of damage from a hurricane or an earthquake.


Herstatt risk

The risk of loss in foreign exchange trading that one party will deliver foreign exchange but the counterparty financial institution will fail to deliver its end of the contract. It is also referred to as settlement risk.


High-Risk Small Business

Firm viewed as being particularly subject to risk from an investors perspective.


Idiosyncratic Risk

Unsystematic risk or risk that is uncorrelated to the overall market risk. In other words,
the risk that is firm specific and can be diversified through holding a portfolio of stocks.


Inflation risk

Also called purchasing-power risk, the risk that changes in the real return the investor will
realize after adjusting for inflation will be negative.


Insolvency risk

The risk that a firm will be unable to satisfy its debts. Also known as bankruptcy risk.


Insurance Policy (Credit Insurance)

A policy under which the insurance company promises to pay a benefit of the person who is insured.


Interest rate risk

The risk that a security's value changes due to a change in interest rates. For example, a
bond's price drops as interest rates rise. For a depository institution, also called funding risk, the risk that
spread income will suffer because of a change in interest rates.


Interest Rate Risk

Possibility that interest rates will rise during the term of a loan thereby increasing the annual cost of borrowing.


Investment tax credit

Proportion of new capital investment that can be used to reduce a company's tax bill
(abolished in 1986).


Investment Tax Credit

A reduction in taxes offered to firms to induce them to increase investment spending.


Job Loss Insurance (Credit Insurance)

Coverage that can pay down your debt should you become involuntarily unemployed. The payment is made to your creditors to reduce your debt owing.


judgmental method (of risk adjustment)

an informal method of adjusting for risk that allows the decision maker
to use logic and reason to decide whether a project provides
an acceptable rate of return


Lease (Credit Insurance)

Contract granting use of real estate, equipment or other fixed assets for a specified period of time in exchange for payment. The owner or a leased property is the lessor and the user the lessee.


Lender (Credit Insurance)

Individual or firm that extends money to a borrower with the expectation of being repaid, usually with interest. Lenders create debt in the form of loans. Lenders include financial institutions, leasing companies government lending agencies and automobile dealers.


Letter of credit (L/C)

A form of guarantee of payment issued by a bank used to guarantee the payment of
interest and repayment of principal on bond issues.


Letters of Credit

A letter of credit is a guarantee of payment by a bank (issuing institution)to a third party for a specific amount of money, if certain conditions are met.


Life Insurance (Credit Insurance)

Group Term life insurance that pays or reduces the balance due on a loan if the borrower dies before the loan is repaid.



 

 

 

 

 

 

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