Default (Investing)

Definition

The term default refers to the failure to meet an obligation on a loan or futures contract. Default occurs when a debtor fails to repay the interest and / or principal owed a lender.

Explanation

Default is said to occur on a bond when the issuer of the security fails to make either an interest or principal payment within a specified timeframe. This normally occurs when the debtor does not have the cash necessary to pay the holders of the bond. Companies or government agencies that issue bonds are extremely reluctant to default on this obligation since it will limit their ability to secure financing in the future.

A country or government agency may be forced to default on a loan if their tax revenues are not sufficient to service their debt. In the same manner, a corporation experiencing declining profits may also fail to have sufficient cash on hand to repay lenders. At the extreme, a company may file for bankruptcy, which means it intends to go into default on all of its outstanding loans.

Bond ratings allow investors to understand the risk of default on a bond. For example, "AAA" bonds are considered very secure with a very low probability of default, while junk bonds carry a rating of "D" are not considered investment quality and carry a high risk of default.

In the context of futures contracts, default occurs when one of the parties to the agreement does not fulfill one of their obligations under the contract.

Related Terms

differential, devaluation, deliverable grades, daily trading limits, currency risk, credit derivative, closing range