Component of Credit Risk
The term sometimes denotes a synonym. But actually credit exposure is a credit risk’s component. Credit risk alone covers the probability of default and recovery rate. By definition, credit risk is a failure of repaying a loan or meeting contractual obligations. It will bring disruption to cash flow.
Instead of credit exposure, default probability estimates whether the borrower is unable to repay the debt. Sometimes it takes one year from a specified period when the borrower is unable to make repayment as scheduled. It is famously written as probability of default or PD. It involves a variety of risk management based on the scenarios and economic environment.
Recovery rate defines the portion of loss that has the recovery chance.
Sometimes, it went through bankruptcy proceedings or efforts such as debt collection. The recovery extends to principal and accrued interest on defaulted debt. Basically, it is the value of security when signs of bankruptcy and defaults happen.
Actually, principal has a lot of meanings in financing. But the term is mostly used in credit risk scope, particularly in recovery rate. It refers to the original sum of borrowed money in a loan put into investment. It could also refer to the face value of a bond. In the context of borrowing, principal is the initial size of a loan or bond where issuers must pay.
Accrued interest in recovery rate is the amount of interest on a specific date on a loan or other financial obligation but paying back the paid out. So, for the lender it is accrued interest or accrued interest revenue. Meanwhile, for the borrower, it is accrued interest expense.