Risk and Return (Part 2)

What is credit risk?

The short answer is, credit risk is the risk that you won’t get your principal back. When you buy a corporate bond, you’re giving money to a company in exchange for a promise to give you money in the future. The time of repayment is usually fixed and contractual—the company can’t reduce or eliminate payments to its creditors without going through bankruptcy, which usually means stock-owners get wiped out and management loses their jobs.

That’s why companies are usually pretty willing to meet their bond obligations. Not doing so can be a disaster. But whether companies are able to pay is another issue. The risk of non-repayment is embodied in the spread between Treasuries—the risk-free rate—and corporate bonds.

The spread gets wider as credit risk goes up. Ba-rated bond, which are just below investment-grade, yield around 3.5% more than Treasuries. Caa-rated, a much lower grade, yield almost 9% more. This implies a 30% chance of loss for Ba-rated bonds, and a 50% chance for Caa-rated bonds.

The risk of loss is built into these spreads. With investing, you never get something for nothing. But by doing your homework you can manage your risk and add to your return.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2013-04-30T08:39:02+00:00 April 30th, 2013|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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