QUESTION: Bonds: how to understand default risk and ratings?
Answer
Default risk and credit ratings play a key role when choosing bonds, especially corporate ones. Default risk means the probability that the issuer will not be able to pay the coupon on time or return the par value of the security. Credit ratings are assigned by specialized agencies and serve as a benchmark for the issuer's reliability, helping the investor assess the company's financial health before purchasing its debt obligations.
For competent risk management when working with bonds, it is useful to apply comprehensive financial analysis and portfolio stress testing.
•Calculate the baseline scenario and stress scenario by assessing the issuer's behavior under crisis conditions or falling revenue.
•Build in a financial safety buffer of 10–20 percent in the portfolio using the most reliable instruments, such as OFZs or gold.
•Decide in advance which expenses, asset shares, or economic sectors you will cut first if market conditions worsen.
Compliance with these rules helps minimize losses from adverse market events and protect invested capital from critical drawdowns.
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