Bond immunization

Can anyone explain when spread widens, duration should be reduced ? My understanding goes this way: When spreads widen, interest rates are increasing/ credit deteriorating, so yield are increasing. When yield s increase, prices decline. I do not make that connection to reduce duration.

derswap07, spread widens => yield up => bond price down To avoid bond price down => reduce duration (not entire price down can be eliminated) Greater duration = Greater price down If I am wrong, just correct me.

AMC, As always, thanks for your quick response. My reasoning: When spreads widen, interest rates are increasing/ credit deteriorating, so yield are increasing. When yield s increase, prices decline. So to minimize the decline, you shorten the duration -in other words, your portfolio’s sensitivity to rates will decline > less losses Am I correct?

derswap07 Wrote: ------------------------------------------------------- > AMC, > > As always, thanks for your quick response. > > My reasoning: > > When spreads widen, interest rates are increasing/ > credit deteriorating, so yield are increasing. > When yield s increase, prices decline. > > So to minimize the decline, you shorten the > duration -in other words, your portfolio’s > sensitivity to rates will decline > less losses > > Am I correct? This makes perfect sense to me :slight_smile:

derswap07 Wrote: ------------------------------------------------------- > AMC, > > As always, thanks for your quick response. > > My reasoning: > > When spreads widen, interest rates are increasing/ > credit deteriorating, so yield are increasing. > When yield s increase, prices decline. > > So to minimize the decline, you shorten the > duration -in other words, your portfolio’s > sensitivity to rates will decline > less losses > > Am I correct? thats my understanding as well

I thought they meant: for a given portfolio, as yield increases the duration falls. Which is true. Are you suggesting the holder should take additional steps to further reduce duration?

Yes, that is the “immunization” part of it. You are helping to make your bonds “immune” their natural sensitivity to interest rate movements by taking steps to reduce the portfolio’s duration. At least that’s my understanding.

In general when spreads widen, the poorer credit is dropping in price faster than the benchmark credit. When yields drop, prices go down and bonds with higher duration drop faster than those with shorter duration. If you foresee this situation, it would make sense to shorten duration and make it more immune to the drop in price.

When yields drop, prices go down - isn’t price go up when yields fall?

i’m guessing he meant ‘when spreads drop, prices go down…’

Hey guys When Spread Widens, Yields Decline, so Prices Increase. So yes "green360, conversely, when Speads Drop, Yields Increase, so Prices Decrease. Agree?

bidder Wrote: ------------------------------------------------------- > Hey guys > When Spread Widens, Yields Decline, so Prices > Increase. > > So yes "green360, conversely, > when Speads Drop, Yields Increase, so Prices > Decrease. > > Agree? When spread widens, assuming that treasuries yield stay the same, yields increase and prices decline- my reasoning. Agree?

Actually…was confused for a second. My initial post is incorrect. Spread on a security increases (i.e. its yield increases) px would go *down* Let’s say a credit weakened, investors would demand a higher yield on the security and prices would be pushed down. Higher duration means you’re more exposed to this downside so would want to reduce duration to immunize this risk.

green360 Wrote: ------------------------------------------------------- > Actually…was confused for a second. My initial > post is incorrect. > > Spread on a security increases (i.e. its yield > increases) px would go *down* > > Let’s say a credit weakened, investors would > demand a higher yield on the security and prices > would be pushed down. Higher duration means you’re > more exposed to this downside so would want to > reduce duration to immunize this risk. I agree totally with this analogy.