Are Treasury securities truly credit risk free? The book claims if the prerefunded bond is properly structured with a portfolio of T debts, then it’s credit risk free. True or false???
In the eyes of the CFAI, yes.
If the collateral consists of tsys and it cannot be touched (held in a trust), , then yes, I would say that you have no credit risk (There is supposedly no credit risk when your counterparty is the US Govt…) The amount of the tsys should be enough such that all future cash flows are covered.
Treasury securities can have credit risk in unusual situations, but generally the gov’t can just monetize the debt by printing money to cover them (the “printing” part is a metaphor). There are some unusual situations in which that doesn’t work: a) Congress is holding up payment on the debt to be jerks and leverage the executive branch into something. This nearly happened during the Clinton Administration. You would have gotten paid, just not on time. b) The inflationary effects of monetizing the debt become worse than the fallout from defaulting on it. That’s usually because of external issues with monetizing the debt and is what happened during the Russian default in 98. Hard to imagine how that could happen to the US anytime soon.
Yes, for this reason alone if nothing else. Treasury securities are fully backed by the U.S. Governement.
Inflation would have to be pretty damn high if they think defaulting would have less of an impact…
In Russia, inflation was about 100% and interest on short-term debt was about 200%. It was very bad.
The concept is that US treasuries are “perceived” to be credit risk free. For CFAI purposes, they are credit risk fee. Put it in another way, if the US gov’t defaults, then the world economy will go to SH*T. People will be fighting and robbing in the streets. Maybe there will be a multiple choice question on the exam that will have the above as a possible answer…lol
I hear that Zimbabwe has a great deal on some government bonds. =P
JoeyDVivre Wrote: ------------------------------------------------------- > In Russia, inflation was about 100% and interest > on short-term debt was about 200%. It was very > bad. Moscow claims to have the most billionaires in the world regardless. NYLS Wrote: > Put it in another way, if the US gov’t defaults, > then the world economy will go to SH*T. People > will be fighting and robbing in the streets. > Who can gurantee US won’t go bankrupt? We are not insured. Till then, it’ll be sovereign risk.
hyang Wrote: ------------------------------------------------------- > JoeyDVivre Wrote: > -------------------------------------------------- > ----- > > In Russia, inflation was about 100% and > interest > > on short-term debt was about 200%. It was very > > bad. > > Moscow claims to have the most billionaires in the > world regardless. > Possibly true. In any event, Russia recovered pretty quickly from a terrible financial debacle. > > NYLS Wrote: > > > Put it in another way, if the US gov’t > defaults, > > then the world economy will go to SH*T. People > > will be fighting and robbing in the streets. > > > > Who can gurantee US won’t go bankrupt? We are not > insured. Till then, it’ll be sovereign risk. We are talking about the gov’t defaulting on dollar denominated debt. Bankruptcy doesn’t apply here because the gov’t can replace all the outstanding debt with newly minted dollars unless there is something to stop them from doing it. In the case of Russia, there was the World Bank, the IMF, and tons of foreign investors who were financing large amounts of Russian debt. Had they continued just printing new money to replace expiring debt, nobody was going to lend them more money. meanwhile the coal miners were rioting in the streets…
I’m not sure whether a country can go bankrupty in case of being invaded; natural catastrophe etc. A municipality sure can (NYC faced near bankruptcy in mid-seventies). In case of being bankrupt, all the muni bonds would be in default. Does this scenario apply to a country?
The big difference is that municipalities can’t print money while the Fed. govt can. NYC stopped payments on their bonds (they told everyone they weren’t defaulting just suspending payment - even as a youngster I scratched my head at that). If NYC could have printed money, they would have done it.
NYC can’t print money (but it has Wall St.) - well, that explains. Thx.