Credit risk is the potential for financial loss arising from a borrower's or counterparty's failure to meet their financial obligations. In trading, it applies to bonds, derivatives, and any transaction where one party may default on payments owed to another. Credit risk is assessed through credit ratings, financial analysis, and credit default swap (CDS) spreads, and is a key factor in determining the yield investors demand on debt instruments.
Example
“A bond investor assesses the credit risk of a corporate bond by reviewing the issuer's financial statements and credit rating. If the company's finances deteriorate, the bond's price may decline as the perceived risk of default increases.”