Comments on: Are Greek bonds pricing in a massive default? http://blogs.reuters.com/felix-salmon/2011/05/26/are-greek-bonds-pricing-in-a-massive-default/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: Publius http://blogs.reuters.com/felix-salmon/2011/05/26/are-greek-bonds-pricing-in-a-massive-default/comment-page-1/#comment-27146 Fri, 27 May 2011 12:21:46 +0000 http://blogs.reuters.com/felix-salmon/?p=8424#comment-27146 Math, math, math.

Take the 30-year Greek bond. Compound it out 30 years. Take the 30-year bund. Do the same. Divide the expected Greek total return by the expected German total return. Then divide by 30.

You will see that the market is discounting a 30% annual loss likelihood over the next 30 years. That is, if Greek-like debt loses money 30% of the time, a rational investor is indifferent between the two. Note: this is a LOSS probability. If you assume a 50% recovery, then the probability of default is 60%.

Through the magic of compounding, a lower 30-year yield is required to discount this same likelihood than is necessary with a 2-year bond. But the probability is similar.

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By: Nameless http://blogs.reuters.com/felix-salmon/2011/05/26/are-greek-bonds-pricing-in-a-massive-default/comment-page-1/#comment-27140 Thu, 26 May 2011 23:16:14 +0000 http://blogs.reuters.com/felix-salmon/?p=8424#comment-27140 Actually I take that back. You can’t treat them as zero coupon, results are badly off. Instead let’s do it right.

Assume that the German 30-year is perfectly safe. Therefore we can use 3.52% as the discount rate to calculate its value. Net present value of future cash flows from €1,000 worth of German 30-year bonds is exactly €1,000 (a tautology).

At the same discount rate, net present value of future cash flows from €1,000 worth of Greek 30-year bonds (assuming no default) comes out to €2,335.

It follows that, in agreement with Thomson Reuters, the market prices something like the near-certainty of a default/restructuring on the scale of 40 cents on the dollar.

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By: Nameless http://blogs.reuters.com/felix-salmon/2011/05/26/are-greek-bonds-pricing-in-a-massive-default/comment-page-1/#comment-27139 Thu, 26 May 2011 22:34:36 +0000 http://blogs.reuters.com/felix-salmon/?p=8424#comment-27139 chappy8: 10.8% on a 30-year is not low. Consider that, if you buy €1,000 of German 30-year bonds (for simplicity, treat them as zero coupon) at the current yield of 3.52%, in 30 years you will get €2,800. But if you buy €1,000 of Greek 30-year bonds at 10.8% and Greece never defaults on them, you will get €21,700. In other words, the market assumes that, at some point down the road, Greek 30-year will get a haircut that makes it lose almost 90% of its value.

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By: Nameless http://blogs.reuters.com/felix-salmon/2011/05/26/are-greek-bonds-pricing-in-a-massive-default/comment-page-1/#comment-27138 Thu, 26 May 2011 22:20:51 +0000 http://blogs.reuters.com/felix-salmon/?p=8424#comment-27138 In 2001 Argentina, markets consistently underpredicted the risk and magnitude of default until the bitter end.

Some stories from back in the day sound eerily familiar.

June 13, 2001: “… The Argentine government is struggling to balance its books and there are fears that it could soon default on its \$130 billion (£92 billion) debt. Earlier this week it only just managed to raise \$800m. Yesterday, Domingo Cavallo, economic minister, launched a series of emergency measures aimed at stabilising the situation. The measures include an 8pc to 10pc pay cut for all government ministers and civil servants, as well as a clamp-down on those who fail to pay their taxes… Standard & Poors, the credit rating agency, cut Argentina’s sovereign debt rating to B-minus from single B and this caused international funds to sell the government’s bonds. This drove market interest rates up to 14.2pc, but they fell back to 13.6pc.”

August 29, 2001: “Argentina’s bonds rose after two days of declines on expectations U.S. Treasury officials may provide details about the country’s planned debt swap in a meeting today with some holders of Argentine debt. Argentina’s benchmark bond due 2005 rose 1.5 to an offer price of 76.81, according to J.P. Morgan Securities. That cut the yield to 22.5 percent.”

November 3, 2001: “The G7 group of major industrialised nations said it was “pleased” with the plan to lower the cost of debt. The International Monetary Fund has twice come to the aid of Argentina since December in a bid to stop the financial woes spreading across the region. A spokesman said a further bailout from the IMF was “not on the cards”. Argentina tied its currency to the dollar 10 years ago and insists it will not renege on this.”

December 11, 2001: “.. the country’s risk premium on bonds jumped amid growing concerns about a possible default on debt payments. The yield on Argentine bonds is now 42.06pc above that of comparable US Treasury bonds…. The Argentine government has little room to manoeuvre as it tries to implement austerity measures so that it can receive the latest tranche of IMF aid that would avert a default on its \$132 billion debt later this month.”

By December 20 there were riots in the streets of Buenos Aires. In January, Argentina defaulted and dropped the dollar peg. Peso fell 70%.

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By: chappy8 http://blogs.reuters.com/felix-salmon/2011/05/26/are-greek-bonds-pricing-in-a-massive-default/comment-page-1/#comment-27136 Thu, 26 May 2011 22:02:37 +0000 http://blogs.reuters.com/felix-salmon/?p=8424#comment-27136 Could you explain why 30-year yields are so low (relative to the 2-year), presumably if the chance of default is high then the 30-year note should have an even higher yield. Isn’t this the whole concept of a ‘normal’ yield curve?

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By: S_2 http://blogs.reuters.com/felix-salmon/2011/05/26/are-greek-bonds-pricing-in-a-massive-default/comment-page-1/#comment-27135 Thu, 26 May 2011 21:02:08 +0000 http://blogs.reuters.com/felix-salmon/?p=8424#comment-27135 This article and http://blogs.reuters.com/felix-salmon/20 11/05/25/why-clearxchange-is-great-for-p ayments/ don’t show up in your Facebook feeded. Technical problem or expected behavior?

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