Credit Risk Management Practice Exam

What is meant by credit risk?

1. The probability that a borrower will not pay back a loan

2. The likelihood of market fluctuations affecting loan interest rates

3. The risk associated with investing in stocks and bonds

4. The chance of obtaining higher interest rates from consumers

The correct answer is: The probability that a borrower will not pay back a loan

Credit risk is defined as the possibility that a borrower will fail to meet their debt obligations, specifically the likelihood that they will not repay a loan. This definition underscores the importance of assessing the creditworthiness of borrowers before extending credit or loans. Credit risk is a central concern for lenders and financial institutions because it directly impacts their profitability and overall risk exposure. The other options relate to different types of risk. The likelihood of market fluctuations affecting loan interest rates pertains to interest rate risk, which involves changes in interest rates that can influence the cost of borrowing and lending. Investing in stocks and bonds involves market risk and other investment risks, which are distinct from the risk posed by borrower defaults. Lastly, while obtaining higher interest rates from consumers may relate to pricing strategies or profitability, it does not define credit risk itself. Therefore, the essence of credit risk lies in the risk of non-payment by borrowers, making the correct answer clear.