Should a debt fund buy five-year AA-rated NBFC bonds at 220 basis points over government bonds? How do you decide whether a class of corporate bonds is worth owning?

Yes, in measured size: after expected loss and a liquidity charge, about 124 basis points a year of the 220 is genuine reward. A 3% five-year default rate with 40% recovery costs 36 basis points a year, and illiquidity costs 60. The class stays worthwhile unless five-year defaults approach 13.3%, but a 100 basis point widening would cost about 4.3%, more than three years of that reward, so size and issuer selection matter.

A moneylender charging 24% when the bank charges 12% is not earning 12 points of profit. Some borrowers will not repay, and his money is tied up where he cannot easily get it back. A credit spread pays for three things: the losses you expect, the illiquidity you accept, and only then a reward for bearing the uncertainty. The interviewer wants to hear you separate them, because a fund that treats the whole spread as profit is paid well right up until the losses arrive.

Expected loss comes first. Three in a hundred issuers default over five years and 60% of face value is lost when they do, so the expected loss is 1.8% over five years, 36 basis points a year. Take the 60 basis point liquidity premiumThe extra yield an investor demands for holding a bond that cannot be sold quickly without accepting a lower price. next. What is left, 124 basis points, is the payment for bearing risk: the chance that defaults come in above average, in a bad year, all at once.

Run it backwards. The reward reaches zero when expected loss eats the whole 160 basis points left after liquidity, a five-year default rate of 13.3%, more than four times the historical figure. A severe stress with 10% defaults would still leave 40 basis points. The danger is price, not default: spread duration of 4.3 years means a 100 basis point widening costs about 4.3% at once, about 3.5 years of excess reward, and NBFC spreads widen together when funding markets tighten.

Buy the class, but not blindly and not in size. The average numbers justify owning it; the decision on any one issuer depends on how it funds itself. For a lender like Ashwamedh, check the gap between the maturity of its loans and its borrowings, its reliance on short-term paper, and how its bad loans have moved over two years. Spread holdings across several issuers so one default costs a known slice of the fund. Say the limit: the 3% default rate is history, and a class that has not been through a funding crisis recently can look safer in the data than it is.