Investment Loss Reserves for Corporate Bond Investors.

The article focuses on the establishment and use of investment loss reserves by long-term broadly diversified corporate bond investors. Long-term bond investment consists essentially of making long-term loans to various types of obligors giving due consideration to appraisal of degree of risk and timing of purchases. These loans may or may not be repaid in their entirety depending upon the fortunes of the particular obligors. It is necessary to develop a general measuring device by which to anticipate credit losses, which might be applied to corporate bonds acquired either through direct placement or through open market transactions. The criterion that would seem to best serve this purpose is the market rating. The market rating is the yield spread or risk premium defined as the difference between the promised yield of a given issue and the promised yield of outstanding issues of the highest-grade bonds that have the same term to maturity. The differences between the averages of promised yields and the modified averages of realized yields, or the modified average of loss rates, indicate roughly how much of the interest receipts would have had to be reserved in order to compensate for losses on the portion of the portfolio that defaulted and on the portion suffering from decline in market value at the end of the study because of credit deterioration.