CFAI curriculum/Schweser state: increases in issuance of new bonds lead to NARROWER spreads. Though counterintuitive, corporate bond returns are best during periods of heavy supply. Questions: 1) Is it really counterintuitive that if I held a bond and its spread is decreasing – due to heavy supply in this case – I’m getting a higher return??? Maybe a better explanation would be: return increases due to a classical microeconomic supply/demand concept? 2) If asked on exam in this context of ‘counterintuiteveness’, should I buy a corporate bond or sell it in a period of heavy supply? Your thoughts appreciated
coming from a fixed income shop, this is definitely true. check out corp spreads over the past 2 months (come in dramatically) where i disagree is at some point supply is so high, spreads start to widen out (last week for instance) however, CFAI is talking more macro, not as micro as the world i work in.
Hmmm… Heavy supply means that price takes a whack. But that doesn’t change the payment stream, so yield goes up. It’s good to buy in a period of heavy supply (buy low, sell high), but not if you think that supply is going to be even higher when you need to sell.
mwtv wrote a good explanation. you can use search to find it.