CFAI Text Reading 29 page 99 # 9 answer states, “the reason suggested as to why heavy supply of investment grade bonds will help spreads contract and enhance return…etc” Then in the answer to #15 on the next page, the question reads, “The manager expects there will be a surge of Single A rated issues that will come to market, resulting in a widening of spreads…” Why does a surge of Single As into the market result in a widening of spreads? Shouldnt it result in a contraction?
i dont have the books but you are right this does seem like a contradiction…can anyone chime in please
so when they say widen, they are referring to the spread between the BBB bond and the Single A bond and are saying that the influx of Single-As will (as the text claims) actually fall, but the widening spread they are referring to is the spread between the A-BBB and not the Treasury Yield-A? ehhh
SkipE99 Wrote: ------------------------------------------------------- > so when they say widen, they are referring to the > spread between the BBB bond and the Single A bond > and are saying that the influx of Single-As will > (as the text claims) actually fall, but the > widening spread they are referring to is the > spread between the A-BBB and not the Treasury > Yield-A? > > ehhh Yes sir. Spend 10 mins for this and then saw elcfa’s solution. Time=wasted
SMH, CFAI with ambigeous mulitple choice questions…sigh!
When a new investment grade issue comes on to the market (i.e., increased supply), the spread between the bond and treasuries will narrow (new supply = increased liquidity = price validation = price of bond gets bid up = yields decrease, thus spread decreases. However, when they refer to widening they are talking about in between issues. For example, let’s say the BBB bond was at 150 bps above treasuries and the A bond was at 100 bps above treasuries. When the new supply of A bond comes to market, we will see that the credit spread of A bonds will narrow to say 80 bps above treasuries. Thus, comparing BBB bonds of 150 bps with respect to 80 bps, we can see the spread between BBB bonds and A bonds “widened”. (before the spread was 50 bps away, now the spead is 70 bps away from the BBB).
thommo you are indeed a gentleman and a scholar.
SkipE99, I think the answer to your questions lies on page 69 of Volume 4 of CFAI. It is not so much the spread between grades of bonds, as it is a communication about pricing in the secondary market. Here is the text: In the investment-grade credit market, heavy supply often compresses spreads and boosts relative returns for credit assets as new primary valuations validate and enhance secondary valuations. When primary origination declines sharply, secondary traders lose reinforcement from the primary market and tend to reduce their bids, which will increase the spread. (Level III Volume 4 Fixed Income and Equity Portfolio Management , 4th Edition. Pearson Learning Solutions p. 69).
nice rbg! highlighted in my book. thanks
I’ve almost made full sense of this question… however, what are people’s interpretation of the first sentence: “a lack of single-A corporate offerings during the fourth quarter has made the paper rich”… What is meant by “rich” here? My instinct is that the single-A spreads over treasuries are low when they are rich (which he expects will result in a surge of issuance), but that flies in the face of them being high when there is lack of supply.
Lack of single As being issued means less supply of singe A’s, means price up, means yields down?
So more supply will cause spreads to widen compared to other issues but narrow compared to the treasury? So odd that more supply boosts the price but I guess there is more supply because there is more demand?
Look at iPhone, new supply has higher prices , even for the secondary market. Ok that is a bit lame
It’s like a Quality-spread analysis applied in primary market.