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Ford Motor Company: How Much Mileage In The Bonds?

Sep. 16, 2013 4:56 PM ETFord Motor Company (F)MS, T

Ford Motor Company (NYSE:F) was one of the thirty most heavily traded corporate bond issuers in the U.S. bond market on September 13, 2013. This note uses the default probabilities and bond spreads of Ford Motor Company to measure the relative reward-to-risk ratio on both firm's bonds. A total of 146 trades were reported on 15 fixed-rate non-call bond issues of Ford Motor Company with trading volume of $27.3 million. After eliminating bad data, we used 144 trades on 14 bond issues in this note. We leave for another day an analysis of spread on the bonds of other legal entities associated with Ford Motor Company.

Institutional investors around the world are required to prove to their audit committees, senior management, and regulators that their investments are in fact "investment grade." For many investors, "investment grade" is an internal definition; for many banks and insurance companies "investment grade" is also defined by regulators. We consider whether or not a reasonable U.S. bank investor would judge Ford Motor Company to be "investment grade" under the June 13, 2012 rules mandated by the Dodd-Frank Act of 2010, which requires that credit rating references be eliminated. The new rules delete references to legacy credit ratings and replace them with default probabilities as explained here.

Assuming the recovery rate in the event of default would be the same on all bond issues, a sophisticated investor who has moved beyond legacy ratings seeks to maximize revenue per basis point of default risk from each incremental investment, subject to risk limits on macro-factor exposure on a fully default-adjusted basis. In this note, we also analyze the maturities where the credit spread/default probability ratio is highest for Ford Motor Company

Term Structure of Default Probabilities

Maximizing the ratio of credit spread to matched-maturity default probabilities requires that

This article was written by

Donald van Deventer profile picture

Dr. Donald R. van Deventer has been in the risk management business since completing his Ph.D. in Business Economics at Harvard University in 1977. He founded the Kamakura Corporation in 1990 after 13 years with two of the 10 largest banks in the US and a stint as investment banker in Tokyo. He joined SAS Institute Inc. as co-head, of the Center for Applied Quantitative Finance in 2022 when SAS acquired Kamakura Corporation. At the time Kamakura was acquired by SAS, Kamakura's institutional clients had total assets or assets under management of 48 trillion dollars.

He leads the investing group Learn more.

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Comments (13)

Donald van Deventer profile picture
Thanks for the post. We'll take on Ford Motor Credit in a later post.
Rubicon Associates profile picture
As well, there should be some form of differentiation between Ford Motor and Ford Motor Credit, and financials have to be adjusted in order to compare them to other industrials without a financing arm. The three year Motor credit at +119/treas is - versus BBB peers - slightly cheap, while the 10yr is not (on the same basis). The CDS implied default probability also jumps in the out years, making a default adjusted "cheap" valuation difficult without a steeper credit curve (which is similar for most BBB and below names due to rating transitions and increased risk of default over time). Like your quant view, it should help determine value when married to a fundamental/market/out... view.
Donald van Deventer profile picture
"While it's cheap" is the right way to think about Ford common stock. The point of my post, which is representative of the way big institutions analyze buy or sell decisions, is that the bonds are expensive, not cheap.
Tdot profile picture
Oh. "Is Ford cheap or expensive?" was meant to ask "Are Ford's Bonds cheap or expensive?".

OK, so Ford's Bonds are expensive. Is that because they are rated at the absolute bottom of the Investment Grade barrel?
Donald van Deventer profile picture
No, it's because retail investors know the product and use that in making the buy or sell decision, exactly as Daniel Kahneman described in our note. The risk return trade off is way out of whack with the average corporate bond.
Kristankenn profile picture
Me thinks ye overthinks. Mr. Ford, although I'm no fan of his politics, certainly stood the test of time and continues to produce qualities cars and increase market shares in the U.S and the world. Ford is keeping up with technology. Ford stock is a great buy now. Analyze away, while I buy it while it's cheap.
"Kahneman (Thinking, Fast and Slow, 2012, p. 12) tells the story of a fund manager who invested in the stock of Ford Motor Company because he liked Ford cars, not because Ford's stock was undervalued in the market place. Kahneman explains, 'The question the executive faced (should I invest in Ford stock?) was difficult, but the answer to an easier and related question (do I like Ford cars?) came readily to his mind and determined his choice. This is the essence of intuitive heuristics: when faced with a difficult question, we often answer an easier one, instead, usually without noticing the substitution.'"

Long ago investment gurus would say only invest in companies who you really understand the products they make. So what is wrong with the quote above?
Tdot profile picture
Understanding the products they make is not the same as liking the products they make. See? You did the substitution and didn't even notice.

So as an example, one might understand that Ford makes cars and trucks in the US, and does so globally as well with major production centers in Europe and Asia, and has a certain amount of market share in certain markets that might be stable or growing, and therefore has relatively predictable revenues and earnings. Knowing what the product is, and how much of it there is, and the competitive environment might constitute a (relatively simple) simple understanding of the company's fundamental earnings potential, and the value of possible investment opportunities. Investing in Ford on that basis would be what the "gurus" from "Long ago" were getting at.

Saying you want to invest in Ford because you like how the C-Max Hybrid or Energi looks, or the mpg that it may or may not get, is not what "the gurus" had in mind. That "liking the product" is a purely emotional connection that has nothing to do directly with earnings potential. By comparison, understanding that Ford has gained (hypothetically) a strong competitive advantage in the C-Max over competitor Toyota's Prius, and that this will create ongoing profit increases, is what the "gurus" had in mind, as an example. Lots of really bad investment decisions, objectively speaking, are made on the emotional type connections, rather than the objective metrics. Tesla may be one of the best examples of that. Sure some short term investing folks have made a fortune betting on Tesla to rise in the last year, but the fundamentals on Tesla's earnings potential and internet-quality bubbly P/E suggests those investors may be in for a whale of a loss if they don't sell out on the cusp of the peak.
Donald van Deventer profile picture
We took the quote somewhat out of context. The long version in Kahneman's book explains that the investment manager did not understand the company nor automotive engineering.
Donald van Deventer profile picture
Thanks for the good comment. I agree and I think Kahneman would too. The hard question (that we tend to avoid trying to answer, choosing an easier question) is "Is Ford cheap or expensive?"
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