Sunday, June 17, 2012

sovereign bonds

An investor can earn some interest by lending money to individuals, corporations and even countries. The question would be, what is the probability of getting your money back. That is where ratings agencies come in who grade bonds from triple A all the way to junk status. Those with a high credit rating pay less interest but would have greater certainty of repaying the whole borrowed amount. The opposite is true for those that are considered more risky, they pay more interest. From an investors point of view, earning 30% from bonds may sound good but attached to that would be a very real possibility of default and thus losing all the investment.  Now here's an interesting exercise, the following shows two groups of countries by their public debt as percentage of GDP:

Group 1:
A. 103% 
B. 208%
C. 108%

Group 2:
D. 49%
E. 40%
F. 24%

If you can lend to one group without looking at their bond ratings, to whom would you lend? To group 1 whose debt is already greater than their GDP, or to group 2. By the way, group 1 is made up of the USA, Japan and Ireland while group 2 is made up of the Philippines, Thailand and Indonesia. It is true for countries as it is to individuals: the path to financial ruin is paved with too much debt.
Happy investing!

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