Definition
The term default refers to the failure to meet an obligation on a loan or futures contract. Default occurs when a debtor fails to repay the interest and / or principal owed a lender.
Explanation
Default is said to occur on a bond when the issuer of the security fails to make either an interest or principal payment within a specified timeframe. This normally occurs when the debtor does not have the cash necessary to pay the holders of the bond. Companies or government agencies that issue bonds are extremely reluctant to default on this obligation since it will limit their ability to secure financing in the future.
A country or government agency may be forced to default on a loan if their tax revenues are not sufficient to service their debt. In the same manner, a corporation experiencing declining profits may also fail to have sufficient cash on hand to repay lenders. At the extreme, a company may file for bankruptcy, which means it intends to go into default on all of its outstanding loans.
Bond ratings allow investors to understand the risk of default on a bond. For example, "AAA" bonds are considered very secure with a very low probability of default, while junk bonds carry a rating of "D" are not considered investment quality and carry a high risk of default.
In the context of futures contracts, default occurs when one of the parties to the agreement does not fulfill one of their obligations under the contract.
Related Terms
The term differential refers to the allowed flexibility to change the quality of the underlying asset in a futures contract. Differential allows the seller in a futures contract to deliver the underlying asset which adheres to a predetermined range of quality specifications.
Moneyzine EditorNovember 6th, 2024
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The term daily trading limit refers to the maximum range a derivative contract is permitted to trade in any one daily session. Daily trading limits are established by the exchange to protect against market manipulation.Moneyzine EditorNovember 6th, 2024
The term currency risk refers to the relative change in the valuation of two currencies and the impact it has on return on investment. Both investors as well as businesses that own assets in countries with different currencies are exposed to currency risk.Moneyzine EditorNovember 6th, 2024
The term credit derivative refers to an agreement that moves credit risk from one party to the other. Credit derivatives were originally used by participants in the banking industry to diversify the credit risk of customers in their lending portfolio.Moneyzine EditorNovember 6th, 2024
The term closing range refers to the high and low price at which trades occurred at the close of the exchange. The closing range would include both bid and offer prices.Moneyzine EditorNovember 6th, 2024
