WHAT IS DEFAULT RISK?

Unfortunately, some businesses do fall upon hard times and are unable to meet their financial obligations.  When a bond issuer fails to make a payment of principal or interest on one of its obligations, it is said to default.  Default risk (or credit risk) is the risk that you will not receive full and timely payment on your bond investment.  When a company defaults on its bond obligation, the investor loses money.  In the worst-case scenario, the company declares bankruptcy; depending on its remaining assets and other financial obligations, you may not receive any further payment.

Although U.S. Government bonds are said to be free of default risk, most other bonds do possess default risk to varying degrees.  Government bonds of lesser-developed countries, municipal bonds, and corporate bonds must be closely examined for default risk by the investor.  

It is one thing to know what default risk is, but it is equally important to know how default risk is measured.  For this, investors use bond ratings.