Expected excess return

CFA Level III
#1

I kinda dont really get how an increase in spread will decrease expected return- according to the formula, a spread widening is subtracted from the return. shouldnt bonds that experience heightened spreads offer higher returns to compensate for said riskiness- i.e. shouldnt we be adding it?

Any clarification would be a huge help

#2

They’ll definitely offer higher returns.

To the person who purchases them from you, _ after _ the price drops.

#3

i dont follow…lol

#4

Let’s say that you but a 5-year zero-coupon, £1,000 par bond yielding 7% for £712.99. Two years later it’s still yielding 7%, the price is £816.30. All of a sudden, its spread widens 100bp, so now it yields 8%, and the price is £793.83. If someone buys it from you, they’ll earn 8%, but you just lost £22.47 (and your investment will have yielded only 5.52%).

#5

much more clear, thank you magician

#6

My pleasure.