Default

A default occurs when a borrower misses a scheduled interest or principal payment, usually after any grace period, or breaks other conditions in its loan or bond agreement. Distressed exchanges, where creditors are pressed to accept new bonds worth less than the old ones, are also generally treated as defaults by rating agencies. For a company, default often leads to restructuring or insolvency proceedings. Governments can default too, and typically negotiate a restructuring with their creditors, since there is no international bankruptcy court for states.

In a company default, investors rarely lose everything, but they are paid in order of seniority. Secured lenders come first, then senior unsecured bondholders, then subordinated debt, and shareholders last, often with nothing left. The share of face value that bondholders eventually get back is called the recovery rate, and it varies widely by seniority and by industry. Default risk is why riskier borrowers must pay higher yields, and why a bond's promised yield is not the same as its expected return. Spreading money across many issuers limits the damage from any one default.