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I 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 wit
by tanderson92 9y ago
I 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.
- taeric 9y agoI guess my cynicism has just grown to the point that I feel some industries have settled on never taking a known loss. That is, this seems like it is the easy answer, and is certainly what folks would do in the small. At large, though, I feel like they are able to have other options. (I fully ack that just because I feel it, does not mean it is the case.)
- tanderson92 9y agoI explained how they're not really taking a loss, since it increases their profits overall. Companies make these decisions frequently; a closely related concept is a loss leader.
- metaphor 9y agoThanks to both you and taeric for keeping the exchange civil.
- taeric 9y agoIf you ever see me being uncivil, please call me on it! I consider it a safe assumption that I was mistaken on anything I'm not an expert on. And on those things, I think the odds might actually increase. :)
- TrickyRick 9y agoSame as with Nespresso machines, the machine is cheap (Probably sold at a loss but I have no numbers on that) because over a lifetime the customer will buy grossly overpriced capsules which will make the money back and more. Game consoles work the same way early in the cycle.
- taeric 9y agoWhat do folks buy as additions to their car? I could see an argument for taking it to dealer's shop. They certainly do what they can to lock out other mechanics. Would be curious on numbers to know how successful that is.
- taeric 9y agoA loss leader has lock in. How does that relate to cars?
- tanderson92 9y agoI did not state that what the car companies are doing is offering the loan as a loss leader; I am saying it is a related concept. I was offering it to help in understanding that companies make tradeoff decisions of this kind. Please don't take my comment as making a direct equivalence between the two.