Question

Determine and evaluate credit risk in the Financial Markets today, and justify why is critical today or in the future (2018-2020 ) of how it has impacted households, businesses, financial institutions, with concrete examples. (One page min)

Answer 1

Credit Risk or default risk;

A firm/individual are considered default when it is unable to service its financial liabilities.

Financial markets provide an opportunity for the investors to invest their money, diversify the risk and increase the returns. Financial instructions are involved in the lending and borrowing business and with the lending of money comes to the risk of DEFAULT.

Let us take the example of the 2008 financial crisis to understand this concept:

As we know that the 2008 financial crisis was majorly caused due to the over lending and involvement of retail banks and commercial banks into investment activities.

The money was lent to the people who were unable to repay it. These loans were called Subprime loans. Because the money was lent to the people who were not able to repay it back, they defaulted.

Although there were other major reasons (Rise in prices of a house, Mortgages backed securities) for the crisis, we can take this as one.

The ultimate effect of it was that all big banks and insurance companies became bankrupt. Many people lost their jobs and the ultimate repercussion was the economy slow down.