And then I remember Long Term Capital Management which, among its many bets, made a trade which is the mirror image to the one I'm looking at and when that relative value trade-long lower rated credits/short treasuries- got squeezed by the flight to treasuries spurred by the Russian default, the firm, it's two Nobel Laureates and all its capital went poof.
So I wait patiently and dream of defaults.
From LearnBonds:
Nine Dynamics of Corporate Bond Default Loss Risk
There are many factors involved in corporate bond default loss risk.
Among these factors are (1) default rates, (2) recovery rates, (3) the cyclicality of default rates, (4) the cyclicality of recovery rates, (5) the relationship between credit rating and default rates, (6) the relationship between credit rating and recovery rates, (7) credit rating drift (which varies by starting credit rating), (8) the relationship between holding period and default rates (which varies by starting credit rating), and (9) the relationship between how senior a bond is and whether or not it is secured and recovery rates.
In this article, we will explore these factors.
Default Rates
To begin with, we should be clearer about what constitutes a default. From what I have seen, the three major credit rating agencies―Standard & Poor’s (S&P), Moody’s, and Fitch―have similar definitions of what constitutes a default. They all include bankruptcies, distressed exchanges (and the like, at least in the case of Moody’s), and missed payments. S&P also includes any “obligor…under regulatory supervision owing to its financial condition” (i.e., issuers rated R by S&P).
Below is a table from the “Fitch U.S. High Yield Default Insight” report covering thru June ‘13. It gives us an understanding of how often the different types of default occurred in the last 1½ years. We can deduce that a missed payment can evolve to be a Chapter 11 (bankruptcy) filing, a Chapter 7 (bankruptcy) filing, or a distressed exchange. In a Chapter 7 filing, a company’s assets are liquidated (i.e., sold) to pay its debts―to the extent they can be paid. In a Chapter 11 filing, a company is rehabilitated via, among other things, easier debt terms and/or partial debt forgiveness. If a Chapter 11 company cannot be rehabilitated, it may file for Chapter 7....MORE
