What are credit risk and interest rate risk in bonds?

• A. Credit risk is about liquidity; interest rate risk is about credit rating.
• B. Credit risk is the issuer's risk of default; interest rate risk is the risk that rising rates reduce bond prices.
• C. Credit risk is price volatility; interest rate risk is issuing risk.
• D. Credit risk only applies to stocks.

Answer: (B)

When you think about bonds, two main risks matter: credit risk and interest rate risk. Credit risk is the issuer’s chance of defaulting on payments, meaning not making some or all of the coupon payments or not returning the principal at maturity. This risk comes from the issuer’s financial health and ability to meet obligations, not from how easily you could sell the bond or from the bond’s credit rating alone. Interest rate risk is the risk that when market interest rates rise, the fixed payments of your bond look less attractive, causing the bond’s price to fall so its yield aligns with current rates. This price sensitivity is greater for longer maturities and for bonds with lower coupons.

So the best description is that credit risk is the issuer’s risk of default, and interest rate risk is the risk that rising rates reduce bond prices. The other statements mix up these concepts or apply them incorrectly (for example, treating credit risk as liquidity or credit rating, or saying interest rate risk is about issuing risk, or claiming credit risk only applies to stocks).