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Subject 8. Credit and Liquidity Risk PDF Download
A change in yield-to-maturity will cause a change in bond price. What is the source of the change in the yield-to-maturity?

The yield-to-maturity on a corporate bond has two components:

  • Government benchmark yield. A change in the yield can come from a change in either of these two components:

    • Expected inflation rate.
    • Expected real rate of interest.

  • A spread over government benchmark. A change in the spread can come from a change in either of these two components:

    • Credit risk of the issuer. This involves the probability of default and degree of recovery if default occurs.
    • Liquidity of the bond. This refers to the transaction costs associated with selling a bond.

Regardless of the source of the yield-to-maturity change, the bond price change caused by a change in the yield-to-maturity will be the same.

In practice, there is often interaction between changes in benchmark yields and in the spread over the benchmark.

Learning Outcome Statements

l. explain how changes in credit spread and liquidity affect yield-to-maturity of a bond and how duration and convexity can be used to estimate the price effect of the changes.

CFA® 2021 Level I Curriculum, 2021, Volume 5, Reading 46

User Contributed Comments 8

User Comment
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