Question on how breakeven spread analysis works: Bond A has a 100 basis point yield spread over bond B for the next quarter… Bond A has a duration of 6 and bond B has a duration of 8. How much must the spread change to negate the 100 bp spread? Ans: 100/8= 12.5. So if the spread widens by 12.5 bps the yield advantage would be negated. Why is this exactly? I guess you’re assuming that Bond B rose in price by 1%, which is why the yield advantage increased by 12.5 bps (cuz if the price rises, the yield will drop)? Is this right? Also, why must you base the analysis by the change that occurs with the bond with the highest duration? Thanks.
it doesn’t HAVE to be with the highest duration, each bond’s prices could change to negate the yeild advantage…BUT if you use the bond with the higest duration, it will utilize the least amount of capital to do so. If prices rise, yield falls - correct.
don’t forget to divide by four for quarterly advantage
he stated in the question that the yeild advantage was already quarterly; if you divide by 4 again, you’d get teh CFA’s trick answer on the exam.