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Not if the auto loan is say 5 years and they're offering 1.5% financing. The 5 year treasury rate is currently 1.76%. So they're losing 26bp of yield for takin
by tanderson92 9y ago
Not if the auto loan is say 5 years and they're offering 1.5% financing. The 5 year treasury rate is currently 1.76%.
So they're losing 26bp of yield for taking on (the albeit limited levels of and partially diversified away) the credit risk?
- taeric 9y agoAgain, they bundled it with other loans. Now, it probably isn't as bad as it initially sounds. But, it is more complicated.
- tanderson92 9y agoAgain, yes that partially diversifies away credit risk. But you're still losing money if you compare to the risk free rate, which is the 5 year treasury on a 5 year loan. Let me just repeat that such a loan is being offered below the risk free rate! It's impossible for bundling to add yield, only decrease credit risk.
- taeric 9y agoOn that loan, yes. But just like nobody would buy magic cards if they knew all of them would be commons, adding just a few rare high value cards will pull the rate that people will pay for the others up. But only as a bundle.
- tanderson92 9y agoYou are incorrect and your magic analogy is flawed.
- taeric 9y agoDo you have recommended reading or links to an overview of how it actually works?
- eru 9y agoA student subscription to the Economist perhaps?
- taeric 9y agoThat my analogy is flawed is not exactly surprising or helpful. It is an analogy and only intended directionally. At best. You two seem to indicate it isn't good at even that. Which is a claim I'm interested in knowing more about.
- tanderson92 9y agoI explained it above. The dual risks in a loan are credit risk and term risk (look those up and learn about them). Since the term is 5 years, the investment with no credit risk is the 5 year treasury (this is the credit risk-free rate). All loans have credit risk. Bundling loans does not eliminate credit risk (this is what 2008 taught us), though it does reduce credit risk. Selling loans with rates below the risk-free rate has negative expected return. The proper analogy is this: treasuries vs. corporate bonds. Here is the current yield spread (difference in interest rate: corporate minus treasury): https://fred.stlouisfed.org/series/BAMLC0A0CM https://fred.stlouisfed.org/series/BAMLC0A0CM The spread is always positive, because investors demand extra yield for taking on credit risk.
- taeric 9y agoI asked you the wrong question, then. What, then, is your explanation for why they make these loans?
- tanderson92 9y agoMy explanation is that they've done the math on how more generous financing encourages more people to buy cars, and that the losses they take on the loans is less than the extra profit they make from the additional car sales.
- Spooky23 9y agoThe manufacturer is subsidizing the interest. It's 1.5% + cash payment.