Which risk is the risk that a bond issuer may fail to repay principal at maturity?

• A. Liquidity Risk
• B. Default Risk
• C. Market Risk
• D. Currency Risk

Answer: (B)

The main idea here is the issuer’s ability to meet a bond’s debt obligations, known as default risk. A bond promises to pay periodic coupons and to return the principal at maturity. If the issuer struggles financially, they may fail to repay the principal when due, or pay only a portion of it. That potential nonpayment or partial recovery is what we call default risk. It’s the credit risk associated with the issuer’s solvency.

This risk is distinct from liquidity risk (difficulty selling the bond quickly or without a large price concession), market risk (price movements from interest rate and market factors), and currency risk (changes in exchange rates for bonds issued in a foreign currency). Higher perceived default risk is usually priced into a higher yield and often reflected in a lower credit rating.