Excess spread formula

CFA Level III Fixed Income
#1

Hello guys,

I’m reading FI Excess spread formula part and the curriculum says
Excess Spread = spread0 - (EffSpreadDur × ∆spread) – (POD × LGD)

My questions is related to the second part - “EffSpreadDur × ∆spread”. I thought this equals to bond price change %. So why we are deducting this from the excess spread (spread0 - POD * LGD)?

Thanks a lot!

#2

The formula is for excess return so if the spread duration changes to your detriment (widens), your excess return will decline.

#3

thanks!