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How does it work when the issuer of a bond defaults on a coupon payment? Does the value of the bond instantly fall to $0, or are allowances made in the hope that future coupon payments might be made?
For example, if you defaulted on a single mortgage payment, the bank would not take your house. However, if you defaulted on numerous payments then I expect that they would.
From a fundamental perspective, the present value of a bond depends on prevailing interest rates, future cash flows (coupon + principal at maturity), and the probability of said cash flows being made on time.
All else equal, if investors have reason to believe that a borrower will miss one (or many) payments, the value of the bond will decrease but it will rarely plummet to zero.
By how much? What you're really asking is what recovery rate can be expected, to borrow a term from the CDS (Credit Default Swap) market.
It depends on the type and severity of the credit event. A single missed payment due to temporary liquidity issues at an otherwise sound corporation would have less of an impact than a string of bankruptcies in a declining industry, for example.
For a single bond, it makes sense to do your due diligence by reading the bond prospectus, checking the credit rating, looking at the balance sheet, thinking about the economic outlook, etc. on a case-by-case basis.
Alternatively, you could invest in an ETF (Exchange Trade Fund) or Mutual Fund that fits your objective to benefit from diversification.
Unless there was no possible chance at all of recouping at least some payments, even if partial, the bond would not be valued at 0.00$. To continue on the analogy of mortgage payments, if you miss mortgage payments, it's likely that when it comes time to refinance you will have to pay a higher interest rate. On the bonds market, the current bonds will be less valuable and therefore command higher yields. If the same firm were to issue new bonds, very likely the market would require a much higher coupon rate or a deep discount to compensate for the risk of a firm that has defaulted on coupon payments.
Not necessarily zero - what typically happens is the company will apply for some form of bankruptcy protection. It could be either a reorganizion of their debts to make payback possible or an all-out liquidation.
Remember that bondholders (at least for first-lien bonds; there can be multiple tiers of bonds) are first in line to get any proceeds from a restructuring or liquidation, which is why they're considered "safer" that equity - stock typically does become worthless in even basic bankruptcy proceedings. Bondholders, on the other hand, often get at least some of their investment back through the bankruptcy process, which could take a while.
Historically, the recovery rate for corporate bonds has averaged about 40%. Waht that means is that companies that declare bankruptcy pay back about 40% of their bonds' par value on average. But actual recovery rates can range from 0 to 100%.
For example, if you defaulted on a single mortgage payment, the bank would not take your house. However, if you defaulted on numerous payments then I expect that they would.
That's not quite how bonds work. If a bond issuer misses one interest payment, it is technically in default. So are you on your mortgage, but banks typically don't typically initiate costly foreclosure proceedings until it's more clear that you won't make up those missed payments.
All the above answers are good and correct.
I would like to add that the buzzwords for this recession seem to be “forbearance” and “solvency”.
https://en.m.wikipedia.org/wiki/Forbearance
The Fed is pushing hard for banks to allow lots of lenient Forbearance. This may require more coordination so that the Fed & Congress work together closely to ensure that banks are incentivized. Banks are ultimately the ones negotiating with individuals.
