Spreads (Fixed Income EOC Reading 21)
Petit develops investment recommendations for a currency- hedged portfolio of US and European corporate bonds. She expects US interest rates to decline relative to European interest rates. Furthermore, the spread curve for US corporate bonds indicates that the average spread of five- year BB bonds exceeds the average spread of two- year BB bonds by +90 bps. Petit expects the difference between average credit spreads for these two sectors to narrow to +50 bps.
OVERWEIGHT the US bonds
UNDERWEIGHT the two years (which have a lower spread), versus the 5y (with a higher spread).
Could someone please explain why?
I understand why you would like to overweight US bonds (you want to be where the lower yields are, so prices of your bonds/bond value is going up).
UNDERWEIGHT the lower spread: OK, so for two bonds of the same rating (and same risk), why would you want the higher spread? Wouldn´t that drive your prices lower, so it is a contradiction to the overweighting reason above?
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