In schweser practice vol1. exam 3am, 9.D, the question asks for the size of the spread-widening that will make total returns equal over the 6 month period… bond Y has yield 7.05% w duaration 6, bond X has yield 4.55% w duration 7. schweser choose bond X to calculate the spd as follows (7.05% - 4.55%)/2 / 7 I understand that it usually picks the bond with largest duration. but the question asks for spread-widnening scneario, it seems we should use the bond with highest yield? Am I wrong?
you should use the bond that the quesiton frames it as. could be the bond with the higher yeild. could be the bond with the lower yeild. could be the bond with thel onger duration. could be the one with the shorter duration the question will specify bond a or b. Jus tmake sure you compute apples to apples. that is, if the question asks for an analysis of bond a…use the spread differential (positive or negative) over bond b and ALSO use bond A’s duration to calculate the break even yeild movement.
Its asking about Spreads Widening. Now this is referring to Single issuer spread b/c you are holding the other spread constant. Now since the Bond B (4.55% 7D) has the lower Yield, it is the Bond who’s spread will need to Widen inorder to make up for the Yield advantage. So [(7.05-4.55)/2]/7 = 17.857bps means that over the next 6 months the spread on Bond B must widen by 17.857bps to match teh Yield on Bond A. Now if I asked how much will spread Narrow. YOu will use Bond A. [(4.55-7.05)/2]/6 = -20.83bps, which means Bond A’s spread must narrow by 20.83bps to lose its Yield Advantage and/or for Bond B’s Yield to equal Bond A’s yield. Remember, we are considering only 1 of the Bond’s spreads not both. If they both Increased or decreased then it would be (7.05-4.55)/2/(7-6) = 1.25% would mean that Spreads overall would need to Increase/Decrease by 125bps to equate the two Yields.
no. Schweser is saying that the higher duration be used ALL THE TIME. Please check the question. No bond is specified, and you pick duration =7 from X, simply because it’s the higher duration. - sticky strikershank Wrote: ------------------------------------------------------- > you should use the bond that the quesiton frames > it as. could be the bond with the higher yeild. > > could be the bond with the lower yeild. > > could be the bond with thel onger duration. could > be the one with the shorter duration > > the question will specify bond a or b. Jus tmake > sure you compute apples to apples. > > that is, if the question asks for an analysis of > bond a…use the spread differential (positive or > negative) over bond b and ALSO use bond A’s > duration to calculate the break even yeild > movement.
Well then I want to say that Schweser is Incorrect. There is no reason to “Always” use the bond with the higher duration…
bigwilly Wrote: ------------------------------------------------------- > Well then I want to say that Schweser is > Incorrect. There is no reason to “Always” use the > bond with the higher duration… and that would be correct
yuppers - Bigwilly and CSK know… check out schweser page 103 question 18…you do a breakeven analysis, like i said, WITH BOTH BONDS…using both the smaller and larer duration.
agree with bigwilly, csk, and strikershank you use duration based on how the question is framed, not just blindly follow “use higher duration” rule
strikershank Wrote: ------------------------------------------------------- > yuppers - Bigwilly and CSK know… > > check out schweser page 103 question 18…you do a > breakeven analysis, like i said, WITH BOTH > BONDS…using both the smaller and larer > duration. if the question has been specific, of course you use the duration of the mentioned bond. What I am saying is that the question does not have to be specific with which bond every time (and I think this is more likely) and for this case, you pick the higher duration to work out a worse scenario. - sticky
the quesiton always will mention a bond. how much the yeild on one has to rise (aka price drop) or how much the other must fall (price increase) the nullify the yeild difference making total return equal (assuming a tax free scenario).
Straight from CFAI material: Volume 4 page 38 (first paragraph after the example) “Note that the breakeven spread widening analysis must be associated with an investment horizon and must be based on the higher of the two countries durations. The analysis ignores the impact of currency movements.” Is everyone as confused on this as I still am?
Big Babbu, the reason for this probably is that break even analysis tries to find the minimal interest rate change that will wipe out yield advantange. This can be done at looking at higher duration bond
I was about to write the same although the logic that BW states here is very reasonable one…
Then I don’t understand what we are trying to discuss … comp_sci_kid Wrote: ------------------------------------------------------- > Big Babbu, the reason for this probably is that > break even analysis tries to find the minimal > interest rate change that will wipe out yield > advantange. This can be done at looking at higher > duration bond comp_sci_kid Wrote: ------------------------------------------------------- > bigwilly Wrote: > -------------------------------------------------- > > Well then I want to say that Schweser is > > Incorrect. There is no reason to “Always” use > the bond with the higher duration… > > and that would be correct
sticky, you are right. we need to define what we mean by “break even analysis”. Is it a minimal parallel shift in interest rate curve which will wipe off yield advantage? If it is then i presume yes, you have to take bond with higher duration Guys, i am trying to understand it myself 
sorry if i confused anyone
And thus my confusion. The logic presented in this thread is totally correct IMO. BUT, the stupid CFAI text says you MUST use the bond with the higher duration. I’ve read it about 20 times trying to find if there’s any way to use the logic BW presented. But I can’t and if anyone can explain that the text is in any way referring to use the duration of the relevant bond please please please explain it to me. So if it comes down to a MC question, what poison are you going to pick.
I am using the higher duration up in this piece!!!
Do both, and if they both show up and it doesnt state which bond specifically then go with Highest Duration bond… If its Essay, then use Highest Duration if it doesnt specify any other way That’s how I will roll b/c if the CFAI text says so then that’s what i do
Ok I have another question on breakeven yield analysis, do you have to take into consideration the currency returns into the yield advantage calc? I am almost positive I have seen this both ways, I don’t understand why you would not take into consideration currency movements.
if you want the minimal rate shift you use the bond with teh higher duration (we’ve been over this with another thread) but step away from the books for a second. breakeven can happen in TWO directions, spreads widen or spreads narrow. And for a widen spread you use the bond with the bigger yeild. With spreads narrowing you’ll use the bond with teh smaller yield. and one of these bonds will have a longer duration with the other. BUT if you want to find breakeve for a narrowing spread and the bond with the smaller yeild also has the smaller duration then you’ll get the question wrong if you use the bond with the bigger duration.