if the manager expects high level of “A” corporate bond issuance, would the credit spread decrease? why would the answer suggests the credit spread would increase creating buying opportunities?
there’s two thoughts I have on this one. In some parts of the curriculum discusses how new issues validate bond prices since they are thinly traded and the increase of bond supply will narrow the spread. However, there are also fundamental supply and demand that could happen, and in this case, i believe the question is alluding to the fact that the supply increase will cause spreads to widen, allbeit temporarly, until the fad passes. At that point, the quesiton says spreads will narrow as more normal returns are expected. if it were only so easy in real life.
I also find this confusing. According to text (p.377, vol 3), “increases in issuance are associated with market-spread contraction and strong relative returns for credit debt”. Now back to solution to part (A), which says “widening of spreads”. Should it be spread widening or contraction, under primary market analysis? - sticky
Well let’s see here…under typical Supply/Demand an increase in Supply will decrease the price and thus increase the Yield and thus spread…However, I do recall CFAI stating that for Bond’s it is typically the opposite. An increase in Bond issuance provides a price mechanism and provides support that creditors are confident in the current market environment, and increases liquidity for the particular issuance. Thus this increases the price of the bonds which decreases the yields and thus spread contraction… So who the heck knows. Under Primary Mkt Analysis I would say Contraction b/c bond prices will be bid up and hence yields will decrease…just my .02
big is correct. this has been discussed before.
bigwilly Wrote: ------------------------------------------------------- > Well let’s see here…under typical Supply/Demand an > increase in Supply will decrease the price and > thus increase the Yield and thus spread…However, I > do recall CFAI stating that for Bond’s it is > typically the opposite. An increase in Bond > issuance provides a price mechanism and provides > support that creditors are confident in the > current market environment, and increases > liquidity for the particular issuance. Thus this > increases the price of the bonds which decreases > the yields and thus spread contraction… So who > the heck knows. > > Under Primary Mkt Analysis I would say Contraction > b/c bond prices will be bid up and hence yields > will decrease…just my .02 so … are we saying solution 15A on A-27, vol 3 is WRONG? It should be “contraction of spread” instead of “widening of spread”? - sticky
An increase in bond issuance is a little different than a high level of a single corporate issuance. Increase in general bond issuance means there’s liquidity in the market, there’s investor confidence/demand, and this is what we’ve seen in the past month or so. But when a single company issues a high level of debt, especially if higher than generally expected, its credit risk increases and credit spreads would have to widen. Just my 0.02
thetank Wrote: ------------------------------------------------------- > An increase in bond issuance is a little different > than a high level of a single corporate issuance. > Increase in general bond issuance means there’s > liquidity in the market, there’s investor > confidence/demand, and this is what we’ve seen in > the past month or so. But when a single company > issues a high level of debt, especially if higher > than generally expected, its credit risk increases > and credit spreads would have to widen. > > Just my 0.02 Please refer to the original question on p.399, vol 3. I think the situation is your “general bond issuance” but the solution is suggesting the spread is widening. Any idea? TooOld4This, where was this topic discussed before? I couldn’t find it. Thanks. - sticky
Under traditional Supply/Demand model you would expect that as the Supply Increases the Prices would decrease, thus Spreads Widening. However, it tends to be the opposite. The increase in supply can be a result of A)increase in demand, b) increase in the outlook for the economy/credit conditions from the issuer point of view or c)people move into new issues for liquidity. So The opposite tends to happen, as new Supply increases, people tend to buy the new issues which drives up the prices and decreases the spreads. I dont know what the original question in the books stated, but I’m sticking to my above belief unless something suggested it would be different :0
Ok I think we’re talking about the same thing but just at different points on the timeline. When a company issues a high of level of debt they’d have to be priced at wider spreads due to increase in credit risk. But when there’s liquidity in the market, everyone will be looking for yield and demand will be greater than supply, so once the new issue starts trading, that’s when you’ll see spreads tighten, hence the buying opportunity.
bigwilly Wrote: ------------------------------------------------------- > I dont know what the original question in the > books stated, but I’m sticking to my above belief > unless something suggested it would be different > :0 I totally understand and agree your belief — this is what’s written in the CFAI text content. The only thing I need from this thread is that could somebody have a read of THIS A/Q15 Rd28 Vol3 page399 and tell me whether the solution there on A-27 is wrong or not? - sticky
Hopefully I’ll remember to read it tonight when I go home…sorry Sticky.
bigwilly Wrote: ------------------------------------------------------- > Hopefully I’ll remember to read it tonight when I > go home…sorry Sticky. It seems you have forgotten this, bigwilly? 
- sticky
When new issues come on the market, the spread between the bond and treasuries will narrow. however, I think they mean “widening” in this case as in between issues. say the BBB were at 50 bps above treasuries and the A bonds were at 45 bps. once we introduce new issue A bonds, we will see that the credit spread of A bonds will be say at 35 bps above treasuries. hence comparing BBB bonds of 50 BPS with respect to 35 bps, we can see the spread between BBB bonds and A bonds widened. (before was 5 bps away, now is 15 bps away from the BBB “relatively speaking” helps?
thanks for the feedback, almo! almo Wrote: ------------------------------------------------------- > When new issues come on the market, the spread > between the bond and treasuries will narrow. This is what I belief as well. > however, > I think they mean “widening” in this case as in > between issues. Not sure if I can fit this “model” into the solution … " … surge of A-issues … resulting in widening of spreads and thereby providing an opportunity to purchase A-issues relatively cheaply vs. BBB issues" What is this “cheaply” describing then? A-issue price cheaper? More input to this apprecated. - sticky > say the BBB were at 50 bps above treasuries and > the A bonds were at 45 bps. > > once we introduce new issue A bonds, we will see > that the credit spread of A bonds will be say at > 35 bps above treasuries. > > hence comparing BBB bonds of 50 BPS with respect > to 35 bps, we can see the spread between BBB bonds > and A bonds widened. (before was 5 bps away, now > is 15 bps away from the BBB “relatively speaking” > > helps?
in my example, The A issue is say trading at 45 bps right now. however after the surge of new issues, the A issues will be trading at 35 bps. if you look at the 45 bps as “currently” and the 35 bps as say the “historical mean” (or you can just think in terms that; investment grade bonds typically trade at a narrow spread compared to other non investment grade issues anyhow). then, given that currently at a 45 bps (wider than usual for this issue), if you were to buy the bond this would be relatively cheap than it’s historical (narrow) basis points of 35 bips. i.e. buy the bond at a relatively cheaper price and wait for the issuance of new bonds, which will narrow the spread and make it rich again. as for the spreads between issues. it’s the only way I can make sense of it as well, as I checked the CFA errata myself and found nothing to report. I’m almost certain they are referring to spreads between issues widening because, the spread of issue will narrow given new issueance with respect to it’s secondary offerings.
Nope, after reading the answer, I think it’s exactly the opposite of what you said Lack of supply of single A paper in Q4 has made it rich compared to BBB paper. Say BBB is trading at 150 over Treasuries and A is trading at 100, and historically the spread btw BBB and A is only 40 bps, so Single A right now is “rich” compared to BBB. Once the flood of single A new issue comes out in Q1, supply may be greater than demand, and you might see single A paper trade down to 125 over treasuries due to this technical, which is only 25 bps inside of BBB, so it’s “cheap” to BBB. Once the flood of supply is done, the manager expects spreads to revert back to the historical 50 bps inside of BBB, hence the buying opportunity in Q1.
I see what you’re saying tank, it’s the difference between the initial flood of supply and then the result. the question breaks it down into steps (as do you) hence that’s where they are describing the widening of the credit spreads…(previous quarter) “ultimately”, credit spreads will narrow (first quarter) and the price for that issue will increase. thanks, a.