Fixed Income II

Reading 46. Understanding Fixed-Income Risk and Return

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 Curriculum, 2020, Volume 5

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Subject 8. Credit and Liquidity Risk

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.

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User Contributed Comments 8

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I think breaking the LOS into segments this way makes debt instruments much easier to study


Flight to quality means that investors would be more interseted in low-return low-risk investments in times of turbulence.


This chapter here in analyst notes is explained in good way


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Im getting way to tired....all I read was stripping to spreading and something rocks....

time to hit the club...


im with you gill


now this makes sense !


gill that was the best comment i've read so far