As e21 has argued consistently since 2009, bailouts are a function of the inherent fragility of the financial system and would be unlikely to come to an end until the size of the required bailout exceeds the economic and political capacity of the putative financial guarantor. With the downgrade of the U.S. and the credit market pressure on France, it is clear that the global financial system has reached or is nearing the point where bailouts are no longer tenable. Unfortunately, as the recent market volatility attests, the financial system is no less fragile.
The price an investor is willing to pay for a debt obligation depends on the probability that he or she will be repaid in full at the time promised in the loan contract or prospectus. This probability is generally a function of the obligor’s cash position, income, and the structure and size of other obligations. Default probability can also be modeled as a function of the borrower’s assets, which can represent either the value of collateral pledged against the loan, or the discounted present value of the creditors’ future income
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