 If possible give brief explanation of how your ans will ensure breakeven (offset yield advantage of one bond over another) 1) Mary Brickland, CFA, is analyzing two different domestic bonds. Bond A has the longer modified duration at 9.50 with a yield of 9.12%. Bond B has a modified duration of 7.30 and a yield of 7.80%. Brickland has an investment-holding period of one year and expects a favorable credit quality change for Bond B to increase its market value during this time frame. If Brickland buys Bond B, what is the required basis point change in the spread (in terms of the required yield on Bond B) to offset Bond A’s yield advantage? A) 13.89474 bp due to a decline in the yield. B) 14.72190 bp due to an increase in the yield. C) 18.08219 bp due to a decline in the yield. 2) Jack Hopper, CFA, manages a domestic bond portfolio and is evaluating two bonds. Bond A has a yield of 5.60% and a modified duration of 8.15. Bond B has a yield of 6.45% and a modified duration of 4.50. Hopper can realize a yield gain of 85 basis points with Bond B if there are no offsetting changes in the relative prices of the two bonds. Hopper has an expected holding period of six months. The breakeven change in the basis point (bp) spread due to a change in the yield on bond A is: A) 10.42945 bp due to a decline in the yield. B) 5.21472 bp, due to a decline in the yield. C) 5.21472 bp due to an increase in the yield. Similar to 1 but made some changes. 3) Mary Brickland, CFA, is analyzing two different domestic bonds. Bond A has the longer modified duration at 9.50 with a yield of 9.12%. Bond B has a modified duration of 7.30 and a yield of 7.80%. Brickland has an investment-holding period of one year. What is the required basis point change in the spread needed to breakeven. A) 13.89474 bp increase in A B) 13.89474 bp decrease in B C) 18.08219 bp decrease in B

For #1: Take the yield difference, .0912 - .078=0.0132, then divide by the duration of the bond that the question asks about, which is B. So 0.0132/7.3=0.00180822. #1 = C Didn’t read 2 and 3 but I assume they use the same method.

The idea of breakeven spread analysis is based on Total Return which is price appreciation + income. Q#3 Bond A Yield = 9.12% Bond A Duration = 9.5 Bond B Yield = 7.8% Bond B Duration = 7.3 If you were to buy Bond A straight out and with no changes in spreads/yield curve over the course of 1 year you will have 9.12% - 7.8% = 1.32% more in total return based solely on income please note if it was 6months divided each on of those in half because you will only have half that income during the course of the year. So for your total return of B to equal that of Bond A the price appreciation will have to be 1.32% to make up for the difference in yield. Duration measures the change in price for parallel shift in the yield curve. We know right off that be that the yield curve has to decrease for the price to go up. For bond B a 1% change in yield will equal a 7.2% change in price but that is too much we only need a 1.32% change in price so… .0132/7.2 = .00181 or .181% or 18.1bps

a) c b) b c) answer A and C are similar?

@ BiPolarBoyBoston : Very nice explanation of breakeven spread analysis. Use of 7.3 duration for Bond B makes sense but why does schweser (also CFAI text) suggests to use HIGHER duration out of two bonds? When to use higher of the two duration rule?

^ I have no clue why you would want to use the higher duration bond. I used Bond B because it ask how much spread needs to change to make the two total returns equal. If Rakesh can post the answer and if its C we can confirm that this is the right way to do the problem.