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Risk Management




Difference Between Credit Risk and Credit Spread Risk


Credit risk is defined as the risk arising from potential financial losses due to the failure of a customer (borrower, debtor) or a counterparty to a financial transaction, to meet its contractual obligations (payment of interest and repayment of principal)- i.e., settlement of outstanding amounts.

On the other hand, a credit spread risk is a type of risk that arises in connection with a credit spread. It is the risk that the value of a position will divert sideways due to changes in the real or market-perceived ability of a borrower to pay the corresponding obligations or cash flows. Credit spread represents the difference in yield between two different exposures that have the same maturity (e.g., a treasury bond and a corporate bond). Difference in yield arises due to difference in the credit risks involved. The credit spread (yield spread) may also represent the difference between the quoted rates of return on two different investments (instruments, etc), usually of different credit qualities (and hence, credit risks) but similar maturities. Credit spread provides an indication of the risk premium for one exposure over another.



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