July 26, 2008

Bonds 101, part 4 - Default rates on bonds

Last time I discussed the different types of bonds. I mentioned that treasuries have virtually no risk and junk bonds have high risks. But what are the risks specifically? Here are the default rates for different bond types:

Default rate on junk bonds = 4.9%
Default rate on municipal bonds = 0.02%
Default rate on Treasury bills = 0%

Corporate and municipal bonds have credit ratings and there are general default levels for bonds of that rating class. Bonds with the highest AAA rating are very unlikely to fail and B rated bonds (Junk) are much more likely to fail.

As shown in the chart, 1 year default rates for bonds at various levels for 1970 to 1995 are:
Aaa = 0.00%, Aa = 0.03%, A = 0.01%, Baa = 0.13%, Ba = 1.42%, B = 7.62%


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