What best distinguishes credit risk from interest rate risk in fixed income?

• A. Credit risk is the risk of issuer default; interest rate risk is price sensitivity to rate changes.
• B. Credit risk is price sensitivity to rate changes; interest rate risk is the risk of issuer default.
• C. Credit risk is liquidity risk; interest rate risk is currency risk.
• D. Credit risk is not a risk; interest rate risk is the only risk.

Answer: (A)

In fixed income, two fundamental risk sources are at play: credit risk and interest rate risk. Credit risk is about the issuer’s ability to meet its obligations—whether the issuer might default on interest or principal. This risk is tied to the issuer’s creditworthiness and can affect the actual cash flows you receive (and the recovery if a default occurs), which shows up in the bond’s yield spread to compensate for that risk. Interest rate risk, on the other hand, comes from movements in market rates and reflects how a bond’s price responds to those changes. When rates rise, most bond prices fall, and when rates fall, prices rise; this price sensitivity is driven by the bond’s duration and is largely independent of the issuer’s default possibility.

So the best choice states that credit risk is the risk of issuer default, while interest rate risk is price sensitivity to rate changes. The other options mix up these concepts or introduce unrelated risks like liquidity or currency, which are not the primary distinctions in this context.