Default Risk for Government Bonds default, recovery, around, price

ikoreaii

Schweser says: "Government bonds are default risk free but are subject to price risk."

IMHO, thats bullsh*t. It would be ok if we still lived in 2007.

Shouldn't we consider a default probability for any bond?

And why is there a formula to calculate the implicit probability of default (given the CDS) - even for US, German or UK-government bonds or any other AAA bond - if there is no default risk at all?

P.S. Assuming a recovery rate of 50%, the default risk for a 10y US-Gov-Note is around 10% (I know that CDS overestimate the probability of default, but still - I won't say there is no probability or "virtually" no probability of default.)

johnnyBuz

Blasphemy! How could a government that's $14 trillion in debt possibly default?

soddy1979

Haha yeah...I understand what you guys are saying....poorly worded answer. On the other hand, if we were to assume that no bond is default-free, then there would be no risk-free rate, which would basically cause all of what we're studying to explode and implode at the same time.

JPSem

There are quite a few instances in the text which in my humble opinion are a world away from reality. Especially when you consider what has transpired in the last few years as people have rightly said. Perhaps it is time to revisit the text.

Moreover, just because the government(any) has the right to print it's own currency does not make government bonds free of default risk. It seems to me that we have to reconsider monetary policy in a Fiat money environment. Just my 2C.

kasinkei

Yes, it's an ethic question. But for me that wasn't the point.

I just did not like the answer "there is no default risk". I read that several times, not only in Ethics, and find it really strange.

In this particular question, it did not make a difference:

A manager says "Since the US government guarantees payment of both the bond's principal and interest, risk of loss with this investment is virtually zero"

This is a violation of the standard on misrepresentation. No doubt.
Explanation: No default risk, but price risk.
My opinion: price risk AND default risk.

farrukhsadiq

Yup. A great deal of what's given as fact in the Economics material has been proven utterly false in the real world, as well. As you have probably learned already, working in finance requires an unhealthy suspension of disbelief.

It's a pseudo-science. The emperor has no clothes. Let's pass this thing and party like it's 1999.

Micholien

Maybe I'm missing something....but I think the point is T-bonds are default free, but still subject to other risks (interest rate risk, reinvestment, etc) so they're not completely "risk-free". Is this from an Ethics question with some portfolio manager saying "T-bills are free of all risks" and it being a violation of Misrep?