Fixed Income II
Reading 47. Fundamentals of Credit Analysis
Learning Outcome Statements
i. describe factors that influence the level and volatility of yield spreads;
CFA Curriculum, 2020, Volume 5
Why should I choose AnalystNotes?
AnalystNotes specializes in helping candidates pass. Period.
Subject 5. Credit Risk vs. Return: Yields and Spreads
Yield spread is the difference in yield between two securities.
- The yield of a corporate bond = yield on a risk-free bond + yield spread
- The yield spread here is composed of the liquidity premium and the credit spread: yield spread = liquidity premium + credit spread
Yield spreads, especially credit spreads, become wider during economic contractions. In times of credit improvement or stability, however, credit spreads can narrow sharply as well. This is known as "flight to quality".
Factors that affect yield spreads include: the credit cycle, economic conditions, financial market performance, market making capacity, and supply/demand conditions.
How do spread changes affect the price of and return on these bonds? The impact depends on two factors:
- The basis point spread change
- The sensitivity of price to yield as reflected by modified duration and convexity
A credit curve is essentially the spread over treasuries of various maturities for a single bond issuer. It is typically upward-sloping, meaning the longer the bond maturity, the wider the spread.
User Contributed Comments 6You need to log in first to add your comment.
Know return impact formula
Im letting this formula slide
This is the same formula we have been looking at. The best way to remember this formula is thinking of Taylor Series.
(-1)*dP/dy + d^2P/dy^2
P = Price
f'(P) = duration
f''(P) = convexity
thks robbie. I missed that f''(P) was convexity. I miss much stuff about maths. ;-)