Portfilio allocation to Bonds

[Snoopy]

If the Bond is rated BBB then I understand that it mean than there is a 1 in 30 possibility, over the 'life' of the bond, that there will be a default on paying the interest or repaying the capital.

Looking at the Reserve Bank published pdf on credit ratings above. This says:

https://www.rbnz.govt.nz/-/media/Res...8179.pdf?la=en

Approx. probability of default over 5 years (The approximate, median likelihood that an investor will not receive repayment on a five-year investment on time and in full
based upon historical default rates published by each agency.) is '1 in 30'.

So let's look at a 5 year time horizon for Contact 040 bonds.

Let's say you are buying the bond in 'year zero' for $10,000, and are paying 30% tax.

Your total expected income over five years is: 5 x ( 0.0375 x 0.7 x $10,000 ) = $1,312.50

The chance your investment will still be intact after 5 years is 29/30.

This implies the chance of losing part of your investment is 1/30:
The worst case here, should Contact Energy fail, is that you will lose all of your investment. Your 'expected' capital loss in this worst case situation is therefore:

(1/30) x $10,000 = $333.33

Some might call that pessimistic. But even if you don't lose all your investment, a partial recovery of what is left might take years. So I think 'total loss' is the real world scenario you should plan for. So I would argue the expected return over five years is:

$1,312.50 - $333.33 = $979.17

This represents an annual net rate of:

($979.17 /5) / ($10,000) = 2%

Compare that with

1/ Buying the Contact shares at a 6% gross yield ( 4.2% net) on market ( approximately true with a $5.50 share price ) and
2/ The possibility of a capital gain from the shares

then the bonds look very unattractive as an 'income generating investment' and an investment in general.

SNOOPY