Question

What are the factors that contribute to credit risk of corporate bonds(please explain in detail)

Answer 1

The factors that contribute to the credit risk of corporate bonds are:

1. Risk of non payment :Unsecured bonds are faced with the risk of non payment of the bond principal at the end of the tenure by the company issuing the bonds. This can be due to liquidity crunch, shut down of the company or market slow down.

2. Risk of non payment of interest: Interest payment annually or semi annually as per the bond conditions is mandatory for bonds and the risk of non payment of interest each period prevails. This may arise due to losses incurred by the company, lack of short term liquidity.

3. Interest rate risk: The bonds yield to maturity may reduce as a result of prevailing market interest rates and may be the bond investment a less worthwhile investment prompting sale of bonds by the investors.

4. Devaluation of the bond: Either due to market conditions or decisions taken by the company the bond's value may fall below par and may not fetch the invested money at the end of the bond period.