University of Central Florida (UCF) FIN4243 Debt and Money Markets Practice Exam 1

The correct choice is focused on a specific risk that relates directly to the issuer of the bond. Credit (Default) Risk refers to the likelihood that a bond issuer will not be able to make the required interest payments or repay the principal upon maturity. This risk is fundamental to bond investing because when an investor purchases a bond, they are essentially lending money to the issuer. If the issuer encounters financial difficulties or insolvency, they may default on their obligations, leading to potential losses for the bondholder.

Understanding Credit (Default) Risk is crucial for investors as it helps them assess the likelihood of receiving the expected returns on their investment. Different issuers (such as corporations, municipalities, or governments) carry different levels of credit risk based on various factors, including their financial health, credit ratings assigned by agencies, and overall economic conditions.

Interest Rate Risk, Inflation Risk, and Liquidity Risk pertain to other aspects of bond investment and do not directly relate to the issuer's ability to meet payment obligations. Interest Rate Risk involves the chance that rising interest rates will lower the market value of existing bonds. Inflation Risk pertains to the erosion of purchasing power due to rising prices over time. Liquidity Risk concerns the difficulty of selling a bond quickly without significantly impacting its