A bond’s promised payments are only as good as the borrower behind them. Credit risk is the chance the issuer can’t pay — and it’s the other big risk in bonds, alongside interest-rate risk.
Default risk
If an issuer runs into trouble, it might pay late, pay less, or not at all — a default. A government that prints its own currency rarely defaults; a struggling company can. The bigger that risk, the more return investors demand to take it on.
Credit ratings
You don’t have to judge every issuer yourself. Rating agencies — Moody’s, S&P, and Fitch — grade issuers on how likely they are to repay, on a scale from very safe to very risky:
AAA (top quality) → AA → A → BBB → … → C → D (in default)
A higher rating means lower assessed default risk — and, usually, a lower yield.
Investment grade vs high-yield
The scale splits into two camps:
- Investment grade (roughly BBB-/Baa3 and above) — relatively safe issuers; lower yields.
- High-yield, or “junk” (below that) — riskier issuers that must pay higher yields to attract lenders.
Neither is “good” or “bad” — they’re different risk-reward deals. Junk bonds can pay handsomely, but more of them default.
The risk–yield trade-off
This is the core bargain of credit: more default risk, more yield. A safe government bond pays little; a shaky company’s bond pays a lot, precisely because you might not be repaid. The extra yield over a safe bond is the market’s price for that risk.
The takeaway
Credit risk is the chance an issuer won’t pay. Ratings grade it; investment-grade bonds are safer and lower-yielding, high-yield bonds riskier and higher-yielding. Higher yield is compensation for higher risk — never free money.