the key components of credit risk—default probability and loss severity—are introduced in the next section along with such credit-related risks as spread risk, credit migration risk, and liquidity risk. the key components of credit risk are risk of default and loss severity in the event of default. market liquidity risk refers to a widening of the bid–ask spread on an issuer’s bonds.
credit ratings enable investors to compare the credit risk of debt issues and issuers within a given industry, across industries, and across geographic markets. that spread is intended to compensate investors for credit risk—risk of default and loss severity in the event of default—and the credit-related risks that can cause spreads to widen and prices to decline—downgrade or credit migration risk and market liquidity risk. the impact of spread changes on holding period returns for credit-risky bonds are a product of two primary factors: the basis point spread change and the sensitivity of price to yield as reflected by (end-of-period) modified duration and convexity. the credit analysis of go bonds has some similarities to sovereign analysis—debt burden per capita versus income per capita, tax burden, demographics, and economic diversity.
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