the more i study, the more i seem to get confused … interest rate risk Vs credit spread risk … can anyone please explain which one is more important to manage ? … i thought only the credit spread is one worth worrying about… if the risk free is 4% and risky bond is 6%… inflation increases by 3%… so 7% and 9% respectively… the credit spread remains unaffected… i’m still earning 2% more than the risk free rate… my bond price should not change bec the overall rates of the economy have shifted… so why do i need interest rate options ? i have a feeling that i’m asking an incredibly stupid question… its just that i have pretty much reached my saturation point and ‘logic & common sense’ just refuse to co-operate anymore
bips Wrote: ------------------------------------------------------- > the more i study, the more i seem to get confused > … > > interest rate risk Vs credit spread risk > … can anyone please explain which one is more > important to manage ? … > > i thought only the credit spread is one worth > worrying about… if the risk free is 4% and risky > bond is 6%… inflation increases by 3%… so 7% > and 9% respectively… the credit spread remains > unaffected… i’m still earning 2% more than the > risk free rate… my bond price should not change > bec the overall rates of the economy have > shifted… so why do i need interest rate options > ? > Do you really think that if you are holding bonds and interest rates increase 2% that your bond price is unaffected? The only time that happens is when the spread is, I dunno, 2000 bp or something. > i have a feeling that i’m asking an incredibly > stupid question… its just that i have pretty > much reached my saturation point and ‘logic & > common sense’ just refuse to co-operate anymore
my brain didn´t work last week… you should take 2 days without studying… I did it this weekend and you don´t know how much better you feel afterwards (and ready to study again, of course)… regarding your question… I think they are more or less independent: + inflation goes up = interest rates go up = yields go up = price of your bond goes down = interest rate risk + credit risk should not be affected by inflation, although you can also say that if inflation goes up because the economy is doing good, overall credit quality improves so credit spreads should go down… or if companies are able to benefit from inflation, exactly the same… but overall I would not link inflation and credit spreads, only to interest rate risk
i know… i’m going to take a break … between work and studies, i have gone completely mad… this is basic stuff and just reading it is giving me headache!.. the more i read my ques, the more i realise how idiotic it is… i just need to stop studying for a little while
Both are important. Interest rate risk is the level of interest rate (affect all fix-income instrument), credit spreak risk is imporant because it has to do with the specific credit qualify of the individual bond you are investing (credit getting strong, bad)
here’s my 2 pennies. besides the broad economy impacts on the credit spreads of a given sector and therefore its performance, many other micro factors are also highlighted in this year’s L3 review including: - cyclical changes (corporate spead narrows during the periods of heavy supply which leads to outperformance); - spread uncertainty for those rated at the boarder of lowest investment grade or highest of junk grade; - general demands for on-the-run issues; - sector rotation trades; - demands for certain structures given an expected movement in volatility and yield curve shape; etc. i guess the credit swap/option market would indicate directions of future credit spreads. it also indicates insurance costs to someone’s bond holdings. it no doubt affects bond investor’s bottom line as a result.
rand0m Wrote: ------------------------------------------------------- > > i guess the credit swap/option market would > indicate directions of future credit spreads. it > also indicates insurance costs to someone’s bond > holdings. it no doubt affects bond investor’s > bottom line as a result. That’s an interesting thought. I wonder if there are good empirical studies about the characteristics of forward spread estimates from the credit derivatives markets.
rand0m Wrote: ------------------------------------------------------- > > i guess the credit swap/option market would > indicate directions of future credit spreads. it > also indicates insurance costs to someone’s bond > holdings. it no doubt affects bond investor’s > bottom line as a result. Pretty much the same arugment can be made on the equity side.