Default Risk refers to the possibility that a borrower, whether an individual, corporation, or government, may fail to meet its debt obligations ó meaning it cannot pay interest or repay the principal on time. It is one of the most important forms of credit risk in financial markets and directly impacts the pricing and yield of debt instruments such as bonds, loans, and debentures.

In simple terms, default risk measures the likelihood that a borrower will "default" or fail to honor their financial commitments. For example, if a company issues bonds and later faces financial difficulties, investors holding those bonds face the risk of not receiving their expected payments.

Assessment of Default Risk: Financial institutions and investors assess default risk using various indicators. One of the most common tools is the credit rating provided by rating agencies like CRISIL, ICRA, or CARE in India. A higher credit rating (such as AAA) indicates low default risk, while a lower rating (such as B or C) signals higher risk. Other factors include the borrowerís financial stability, cash flows, leverage ratios, and economic environment.

Impact of Default Risk:

• On Interest Rates: Borrowers with higher default risk must pay higher interest rates to attract investors, compensating them for the additional risk.
• On Investments: Investors may prefer safer assets, such as government securities, over high-risk corporate bonds, especially in uncertain market conditions.
• On Financial Markets: Widespread defaults can lead to loss of investor confidence, liquidity crunches, and systemic risks in the economy.

Managing Default Risk: Lenders and investors mitigate this risk through strategies such as diversification, credit analysis, collateral requirements, and credit default swaps (CDS). Regulators also monitor the credit system to maintain financial stability and protect investors.

In conclusion, default risk is a critical factor in debt investing and lending decisions. Understanding and evaluating it helps investors balance risk and return, ensuring more informed financial choices in both corporate and personal finance contexts.