3.5 Default or credit risk
This is the risk that contractual returns will not be paid because the borrower's financial situation has deteriorated to the point that it is no longer able to service the debt. It is possibly the commonest type of risk in commerce generally, and you are probably familiar with it in some shape or form. It affects many areas of business decision-making over and beyond the specialised world of investment risk and return. Most large companies devote significant resources to the identification, control or elimination of credit risks incurred in the normal course of their trading activities. What gives it a special dimension in the investment context is the issue of maturity, noted in Section 3.2. Making a long-term loan to a company clearly poses a greater credit risk than granting the company normal 30-day credit terms for the supply of goods and services. Not surprisingly, the analysis of borrowers’ long-term creditworthiness is a big business in itself.