What type of risk does the term 'credit risk' refer to?

Credit risk specifically refers to the possibility that borrowers may fail to meet their obligations as outlined in a loan agreement, ultimately leading to default. This risk is inherent in lending activities, where a lender provides funds with the expectation of being repaid, including interest. When borrowers default, lenders may face significant financial loss since they may not recover the full amount of the loan. This risk is particularly relevant in the banking and financial sectors, where assessing the creditworthiness of borrowers is crucial for mitigating potential losses.

The other options deal with different types of financial risks. For example, fluctuations in currency exchange rates pertain to foreign exchange risk, while the risk of financial loss in derivative transactions refers to market risk and counterparty risk. Lastly, the risk of assets losing value due to market volatility relates to investment risk or market risk. Each of these concepts, while important in their own right, does not specifically define credit risk.