What is the difference between market risk and credit risk?

What is the difference between market risk and credit risk?

• A. Market risk arises from overall market movements; credit risk arises from a borrower defaulting.
• B. Market risk arises from borrower default; credit risk from market movements.
• C. They are the same concept.
• D. Market risk applies only to currencies.

Answer: (A)

The main idea here is the source of the risk. Market risk comes from movements in the overall market that affect asset prices across many securities—driven by factors like interest rate changes, broad economic news, or shifts in investor sentiment. It isn’t tied to any single borrower. Credit risk, by contrast, is about a counterparty’s ability or willingness to meet its obligations; if that borrower defaults, you could lose part or all of your investment. So the correct statement captures this difference: it says market risk arises from overall market movements, while credit risk arises from a borrower defaulting. That distinction is what makes market risk a broad, market-wide issue and credit risk a concern focused on creditworthiness and default, not on general price swings. The other possibilities mix up the sources or scope. Saying market risk comes from borrower default reverses the idea, claiming market risk is about a single counterparty’s failure. Saying they’re the same concept ignores the distinct mechanisms behind price changes versus creditworthiness. And saying market risk applies only to currencies is false, since market risk affects many asset classes, including equities and rates, not just currencies.

The main idea here is the source of the risk. Market risk comes from movements in the overall market that affect asset prices across many securities—driven by factors like interest rate changes, broad economic news, or shifts in investor sentiment. It isn’t tied to any single borrower. Credit risk, by contrast, is about a counterparty’s ability or willingness to meet its obligations; if that borrower defaults, you could lose part or all of your investment.

So the correct statement captures this difference: it says market risk arises from overall market movements, while credit risk arises from a borrower defaulting. That distinction is what makes market risk a broad, market-wide issue and credit risk a concern focused on creditworthiness and default, not on general price swings.

The other possibilities mix up the sources or scope. Saying market risk comes from borrower default reverses the idea, claiming market risk is about a single counterparty’s failure. Saying they’re the same concept ignores the distinct mechanisms behind price changes versus creditworthiness. And saying market risk applies only to currencies is false, since market risk affects many asset classes, including equities and rates, not just currencies.