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Member (Idle past 97 days) Posts: 10333 From: London England Joined: |
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Author | Topic: Keynesian Economics and Recession Counter-Measures | |||||||||||||||||||
cavediver Member (Idle past 3674 days) Posts: 4129 From: UK Joined: |
The advantage to bonds is that they are more secure than shares I wouldn't use the word "secure" here. Shares don't really have a measure of security - they are simply a traded commodity. You will always find a buyer willing to pay what he thinks is the fair value for the shares you hold, even if that value is zero And dividend payouts are purely at the discretion of the corporate entity. Bonds on the other hand have a maturity when the principle is returned, plus a pre-agreed level of interest paid at intervals and/or at maturity. The issuer of the bond is thus obligated to pay, and if he will not/cannot, then he is in default. The security of a bond is the assessment of likelihood that the issuer will default. Thus corporate bonds are usually considered less secure than government bonds - but this is by no means universal. Microsoft debt is certainly much more highly rated than South American Debt, for example.
and earn more than sticking the money in your bank Although current accounts typically pay little or no interest, you will find a savings account with a bank that will pay better than the equivalent term government bond. The bank will rarely be better rated than the government, and thus must pay more interest to offset the associated credit risk. The reason the Icelandic banks tempted UK investors with such high rates of interest was not out of their generosity, but because their credit rating was low. Ask me how much sympathy I have for those non-nationals whining about their lost Icelandic investments
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cavediver Member (Idle past 3674 days) Posts: 4129 From: UK Joined: |
So if a currency is falling in relation to other currencies, short term bonds in that currency are an obvious money loser? No, because you are confusing past (FX) performance with future (FX) performance. Just because the currency has fallen does not mean it will continue to fall - if it did, we'd all be rich (at least those of us trading in the FX markets) - look at the past few days cable (GBP/USD) trading, compared with the past four weeks...
If so buying bonds in a particular currency is little more than currency speculation in the longer term? Yes, it is future currency speculation (with spots on the interest payment dates and the maturity), but also credit speculation to a greater or lesser degree based on the debt issuer, and also rate speculation (buying a 10yr 4% bond the day before rates leap to 10% is a bit of an arse).
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cavediver Member (Idle past 3674 days) Posts: 4129 From: UK Joined: |
Shares do have a little bit of security of course, it gives a shareholder a claim on some part of what the company owns with limited liability in case of bankruptcy. True, though as you say, the assumption in this case has to be that you will get nothing - the shareholders are way down in the list of bankruptcy beneficiaries. But my point is more important. Security and risk have specific meanings in finance and are easily confused. Falling victim to this confusion is extremely dangerous and could easily lead to a global credit-risk-driven financial meltdown. Fortunately, this is very unlikely to happen, as most people are not at all confused by financial terminology... This whole crisis has been caused by one thing - confusion and ignorance over highly secure, yet extremely risky investments. This is exactly what happened ten years ago with the emerging market "crisis" (I don't think that word applies any more, given perspective.) Back then, it was credit linked notes. This time it's mortgage backed securities. Same old, same old. Ask me if I'm surprised
Well yes, then again, when you put the money into a savings account it gets put to work in shares and bonds and the like. Yes, but this is only one part out of the three principle components of the return: inflationary compensation, opportunity cost, and credit risk. The last is often forgotten, yet is by far the most important and accounts for the largest variation in rates across Western government and corporate issuers.
Seriously though, thanks for the clarifications. No problem. Can you guess my post-academia career or should I say
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cavediver Member (Idle past 3674 days) Posts: 4129 From: UK Joined: |
OK, I concede, you've out 'yes-but'ed me. I've got man-flu, so I've an excuse for being cranky - getting as anal as Rrhain
I'd appreciate some kind of explanatory expansion on this. Sure, and I'll try to make it understandable by everyone so please forigive if this sounds too simplistic to you. Opportunity cost is what you've already mentioned, the ability of cash to do work. If you give your cash to someones else, you need compensating for what that cash could have done for you if you'd done something else with it: started a business, invested in a growing business, gambled on a 'sure-thing', etc. Inflation works to devalue a fixed sum of money, so you also need compensating for the fall in value of the cash over the time of the bond: if $100 today will buy you a week's shopping, what you want back at the end of the bond is the sum of money that will again buy you a week's shopping, even if that is now $120. Credit risk is the risk that the issuer of the bond will default on his obligation to you - either by only paying back a fraction of what is owed, or not paying anything back. The riskier the issuer, the more he needs to pay you in return to compensate you for taking that risk. The Icelandic banks had been seriously down graded in credit worthiness by the credit rating agencies, and so to attract investors, the banks were having to offer interest rates of around 15%. That huge hike in interest is purely down to risk. You invest at your peril - as many did, not understadning that there is no such thing as a free lunch. For a sovereign triple-A rated issuer such as the US government, the credit risk is essentially zero, so the rate offered on T-bonds is just the inflation plus the opportunity cost. A smallish national bank will have a definite measure of risk, and will have to offer greater rates. ABE: for those of us in the UK who remember back to the early 90s, there can be another element to the rate offered by a state, and that is pure enticement to encourage foreign investors to buy your bonds. Because the bonds are denominated in your own currency, the foreign investors must purchase your currency to buy the bonds, thus improving the value of your currency. This is what the UK Tory government did in a spectacularly failed attempt to preserve the value of the GBP in order that we not move outside the bounds dictated by the European Exchange Rate Mechanism (ERM) - this cost us an effin fortune (billions) (a large part of this ended up in George Soros' pockets!) and is known as Black Wednesday. Edited by cavediver, : No reason given.
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cavediver Member (Idle past 3674 days) Posts: 4129 From: UK Joined: |
I am less interested in theory and more interested in results. said the chief fund manager to the quant, when the quant tried to explain why all the Mortgage Backed Secuities on the balance sheet that were paying 20% were actually a really BAD idea No-one heard you complaining during the boom. Funny how no-one asks questions when everything is *looking* good. We've had our "results" upfront and now we're paying for them. And it will take a long time to pay them off. Short-term fixes are no answer - theory is critical, otherwise it's just guesswork. The banks still have little idea of just how much crap is on each other's balance sheets - is it all that has been owned up to, is it double, is it ten times??? Would you lend to one of these banks??? What is required is published independent highly quantitative analysis of each bank, of a calibre that the banks will trust, and with sufficient enforcement by the government and regulatory bodies that it is unhindered. Throwing money at the banks is not so helpful. You don't scatter sweets on a minefield to tempt you to cross - you find out where the mines are. Then attempt to remove them.
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cavediver Member (Idle past 3674 days) Posts: 4129 From: UK Joined: |
Grizz writes: Nobody trusts the banks, not even their peers. Until this trust is restored, this problem will not reverse itself. We can take a guess as how to accomplish this, try it, and see if it works. If it doesn't, you guess at something else and try it until something kicks in. I've already told you the solution, and it's not a guess. We know why the banks don't trust each other - lack of information. We give them that information. Simple. Getting the banks to agree to this level of outside scrutiny - not so simple. But who cares about agreement - it is enforcement we need now. As I said:
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cavediver Member (Idle past 3674 days) Posts: 4129 From: UK Joined: |
Credit default swaps should be eliminated or tightly regulated. Credit default swaps don't kill people, traders* do (*actually, highly ignorant fund managers...)
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