Downgrade risk is the risk that a bond price will decline due to a downgrade in its credit rating. Credit ratings, assigned by agencies such as Moody's or S&P, are indicators of default risk (the possibility that the issuer cannot pay the bondholder) on a particular bond. Lower ratings suggest that a bond issue is riskier than an issue with higher ratings, which in turn leads to a lower price. A downgrade, therefore leads to a lower price.
The downgrade risk arises from deteriorating financial condition of a company, and every bond faces this risk to a certain extent.
