Case Studies (Real-World Applications)
Case Study 1: Bank Loan Default
Situation:
A borrower fails to repay a loan.
Outcome:
- Bank incurs loss depending on collateral
Insight:
Credit risk directly affects financial stability.
Case Study 2: Corporate Bond Investment
Situation:
An investor buys corporate bonds.
Outcome:
- Higher yield reflects higher credit risk
Insight:
Risk and return are closely linked.
Case Study 3: Credit Default Swap Protection
Situation:
An investor holds risky bonds.
Strategy:
- Buys CDS protection
Outcome:
- Loss is reduced if default occurs
Insight:
Credit derivatives help transfer risk.
Case Study 4: Financial Crisis Impact
Situation:
During a crisis, many borrowers default.
Outcome:
- Credit risk increases across the system
Insight:
Credit risk can become systemic.
11. Key Takeaways
- Credit risk is the risk of default or non-payment
- Measured using PD, LGD, and EAD
- Managed through diversification, collateral, and monitoring
- Credit derivatives (like CDS) help transfer risk
- Plays a critical role in financial markets and stability
12. Quick Practice
Scenario:
A company has a high probability of default but strong collateral.
Question:
- Which component (PD, LGD, or EAD) is most affected?
- How does collateral influence overall credit risk?