DEFINITION:
Default risk is the possibility that a borrower will be unable to meet their financial obligations, resulting in a failure to repay a loan or bond.
WHEN AND WHY IT’S USED:
Default risk is used to evaluate the safety of fixed-income investments by estimating the likelihood that the issuer will default on its debt. Higher default risk typically requires a higher yield to compensate investors for taking on additional risk. This concept is particularly important in assessing corporate bonds, emerging market debt, and other high-yield investments.
IMPORTANCE IN COMMUNICATION:
Clear communication about default risk with your advisor helps you understand the inherent risks in fixed-income investments and guides you in making informed decisions. It builds trust by ensuring that the level of risk in your portfolio is consistent with your financial goals and risk tolerance. Discussing default risk allows you to review strategies for diversifying credit exposures and minimizing potential losses.
Additionally, this dialogue enables you to ask questions about the creditworthiness of various issuers and the measures taken to monitor and manage default risk. Transparency on this topic is essential for a well-rounded understanding of your portfolio’s risk profile and for making strategic adjustments as market conditions change.
EXAMPLES IN COMMUNICATION:
“What measures can we take to reduce default risk in my bond holdings?”
“How does default risk affect the yield requirements for the securities we’re considering?”