Constant Default Rate - CDR

Finance allah shmoop What are the major risks in owning

bonds Okay so first thing about risk Like if you're

one of those people who worries about asteroids dinosaur inhumanity

Well then really the best place for your savings is

probably in a certain aura casper Or you know whatever

mattress brand you like Yeah go stuff those twenties into

their sleep on them And well we guess you pray

a lot Well if you have a bit more tolerance

for risk than buns air calling for you Historically most

funds are safe They boringly go along and pay their

interest and principal and investors get their five point two

eight nine seven percent returns or whatever the number is

And that's it No heroes no goats just interest payments

and peace So the bottom quartile of bonds i e

V e riskiest quarter of them is still way safer

than almost any equity or stock So the risks in

bond ownership kind of come from a different place not

necessarily from bankruptcy and the bonds not paying And yes

there exists a risk numeral you know in the company

or municipality or state going bankrupt Hello illinois California We're

looking at you and not paying the interest they oh

but that's an obvious risk and really rare in the

scheme of things Like in all the bonds issued its

some number in the very low zero point something percentages

of bonds that actually don't finally pay And this number

varies highly by era that is in the mortgage crisis

of a wave no Nine while there was a huge

spike in the number of bond delinquencies But in normal

eras where the world isn't in fact teetering on the

edge of bankruptcy a bond default is really rare So

the risk in bond ownerships more about the opportunity cost

of not owning stocks huh How's that go Well historically

the stock market is compounded it seven eight nine ten

percent a year and it doubles in value every seven

eight nine ten years Something like that Bonds with consummately

way less risk not surprisingly offer away less reward and

frankly poor tax structure because bond interest is tax at

ordinary income and stock appreciation is intact until you sell

it And even then it's tax at long term gain

rates usually so bonds compounded about half the rate of

the stock market or stocks or less obviously depending on

how much risk those bonds carrie right relative to where

we are in the market cycle and so on But

if you're feeling frisky and you buy junk bonds or

high risk or high yield bonds well there are other

risks beyond bankruptcy or looking over your shoulder and watching

the stock market boom While you're getting only eight percent

in year interest pre tax on your bonds right That

risk calls that is bond's yielding a whopping eight percent

have the risk that they get called early and refinanced

for only five percent The transaction makes a ton of

sense for the company who issued those high priced bonds

It stays a mil three percent a year on big

dollar amounts and that could be huge like taking a

four hundred million dollars of debt And instead of paying

eight percent on that well you're only paying five percent

or something like that right But the risk then extends

to the investor who thought they were buying a nice

set of cash flows at eight percent on i'll say

the hundred grand they invested or they'd get eight grand

a year in interest on that investment bonds only to

wake up one day with their hundred grand re funded

maybe with a grand or two in premium or tip

to say thank you for the short ride pal with

the company then offering the same risk bonds for just

five grand a year in bond rent money instead of 00:03:26.21 --> [endTime] eight So yeah