How Do You Calculate Default Risk Ratio?
“Default” risk is a type of risk that a borrower will not repay on a loan. This risk is also called, “Credit Risk.” Default risk, or any other risk for that matter, requires an additional interest repayment (called a “Risk Premium”) above a “Risk-free” benchmark interest rate. This article will discuss how to calculate the risk premium as a ratio. Define your risk-free rate. In the United States, corporations issue debt in the form of bonds. A corporate bond is riskier than a bond that is backed by the taxing power of the government and carries a credit-risk premium. The common risk free rate in America is the rate of U.S. treasury bills. This is the risk free rate. Determine the credit worthiness of the debt issuer (bond issuer, in our example). This is a bit tricky to do without sophisticated software, however it is manageable. In our example, we’ll compare the debt of a large, stable U.S. corporation to that of a small sandwich shop that has just opened in a bad part of town. The la
