Poll: Suppose the U.S. government raised funds w/ a special treasury security that pays a coupon guaranteed to be equal to the aggregate dividend of the S&P 500. Right now, that's ~$14 per quarter, $56 for the year. What price would the treasury security trade at?
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The default risk is embedded in the cash flows that the high yield bonds pay out! If they default and don’t pay, the “government backed” fund doesn’t pay them either because it pays the exact same cash flows.
With the bond you suffer a loss of principal when it defaults. With the government security you don’t — the bond is just replaced with another one and the yield is ~unchanged. You have the cash flows without most of the default risk (only the coupon is at risk, not the principal)
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Similarly if an equity goes to zero you lose the dividend *and* all your capital, ie you lose all future dividends from that stock. But the hypothetical government security will continue paying dividends since the stock is replaced in the index.
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Even easier way to see it - suppose all the stocks went bankrupt at once. Then the index return is -100%. But the stocks will be replaced with the next biggest 500 stocks at the next rebalance, and will continue paying a dividend - the govt security hardly suffers at all.
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The principal is reduced because of uncertainty or elimination of the cash flows... those cash flows are identical in the government version so the value would be reduced as well.
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Hmm, maybe there is some confusion about how the dividend is paid. Does it pay principal x div yield of index? Or does it pay dollar value of SPX dividend?
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