Default

Definition

Default occurs when a bond issuer fails to make the required interest payments or principal repayment on time. It signifies a breach of the bond's terms and can lead to severe financial consequences for both the issuer and bondholders.

5 Must Know Facts For Your Next Test

1. Default can be partial (missed payment) or total (complete inability to pay).
2. Bond ratings are used to assess the likelihood of default, with lower ratings indicating higher risk.
3. A default can trigger a chain reaction, impacting an issuer's credit rating and increasing borrowing costs.
4. Investors can lose all or part of their investment in case of a default.
5. Governments, corporations, and municipalities can all be issuers that might default.

Review Questions

• What is the primary consequence for an issuer who defaults on a bond?
• How does default risk affect a bond’s interest rate?
• What role do credit ratings play in assessing default risk?

Related terms

Credit Rating: An assessment of the creditworthiness of a borrower, often influencing the interest rate on bonds.

Interest Payment: The periodic payment made by the issuer to the bondholders as compensation for borrowing funds.

Principal Repayment: The return of the original amount invested in a bond at its maturity date.