Two portfolios have the same portfolio duration but one of them has a higher nominal spread duration. How does the higher spread duration affect the portfolio characteristics? The higher spread duration portfolio will have: A) the same exposure to small parallel shifts in the Treasury curve but will have a higher exposure to changes in the yield difference between non-Treasury and Treasury bonds. B) the same exposure to small parallel shifts in the Treasury curve but will have a higher exposure to changes in the yield difference between long and short-term Treasury securities. C) a higher exposure to small parallel shifts in the Treasury curve and a higher exposure to changes in the yield difference between non-Treasury and Treasury bonds.
A
a for me too basically has the same duration regarding interest rates but it is more affected to changes in spreads because it probably is a lower credit bond
I saw that problem in the Qbank and it threw me off as well. I agree that A is the correct choice. But I didnt get this one when I first saw it.
yup. fixed income will be the end of me Your answer: C was incorrect. The correct answer was A) the same exposure to small parallel shifts in the Treasury curve but will have a higher exposure to changes in the yield difference between non-Treasury and Treasury bonds. Nominal spread is the spread between the nominal yield on a non-Treasury bond and a Treasury of the same maturity.
A, yo.
A Yep, spread duration is about sensitivity to credit spreads. For normal straight bonds, spread duration = bond duration, but in portfolios, if there is some a correlation between your credit risk and your duration (for example, short maturities are all treasuries, but long maturities are corporates), then spread duration <> ordinary duration.
I have a question: Does the portfolio with higher spread duration have a low sensitivity to Treasury curve shift?
No… spread duration tells you nothing about how a Treasury curve shift affects the portfolio. That’s why it’s called the spread duration rather than just plain old duration. In many cases spread duration = ordinary duration (like for single bonds that have credit risk), and that’s why it can get a little confusing. Remember - only bonds and portfolios with credit risk have spread duration. Treasuries have duration of D but spread duration of zero.
bchadwick Wrote: ------------------------------------------------------- > That’s why it’s called the spread duration rather > than just plain old duration. In many cases > spread duration = ordinary duration (like for > single bonds that have credit risk), and that’s > why it can get a little confusing. I was looking at the readings trying to find an example where spread duration=effective duration. Do you know where I can find it because I don’t understand how this could occur? Thanks.
I don’t either ^
I don’t have the readings so, I don’t know where it’s said, but here’s the logic… Duration is just the change in price per change in the yield that the market demands (effective duration is %change and dollar duration is the dollar change). Spread duration is the change in price per change in the credit spread. The market yield demanded for a security is composed of RFR (treasury yield) plus Credit spread. Yield = RFR + CreditSpread Change in Yield = dYield = dRFR + dCreditSpread (where the d-prefix means “change in”) so… Change in price = Duration * (dRFR + dCreditSpread) = Duration * dRFR + Duration * dCreditSpread = Duration * dRFR + (Spread Duration) * dCreditSpread. If the security is a treasury security, SpreadDuration=0, because treasuries have no credit risk. For other ordinary bonds, Duration=SpreadDuration. It is possible that there are some circumstances with embedded options or covenants that might make the SpreadDuration<>Duration for a credit bond. Or the bond might be a floating rate bond with a special provision that sets the coupon based on credit risk (LIBOR has a little credit risk embedded, but those bonds typically have duration close to 0). For portfolios, however, you can find that SpreadDuration<>Duration if the credit risk is not evenly distributed throughout the portfolio. For example, if you have a barbell portfolio, but one end has all the credit risk and the other end is all treasuries, then the portfolio Duration<>SpreadDuration.