Portfolio Management - Economics and Investment Markets; Intuition behind Credit spreads narrowing and widening

CFA Level II
#1

Following passage is taken from Schweser, can someone simplify this concept so that it can stick in my head: When credit spreads narrows, credit risky bonds will outperform default-free bonds. Overall lower rated bonds tend to benefit more than higher rated bonds from a narrowing of credit spreads (their yields fall more). Conversely, when credit spreads widen, higher rated bonds will outperform lower rated bonds on a relative basis (because their yields will rise less).

#2

Suppose that the 5-year par Treasury rate remains unchanged, but 5-year credit spreads change.

  • If the credit spread widens, the YTM on a risky 5-year bond increases, so the bond loses value; 5-year Treasuries are unchanged. Treasuries outperform risky bonds.
  • If the credit spread narrows, the YTM on a risky 5-year bond decreases, so the bond gains value; 5-year Treasuries are unchanged. Risky bonds outperform Treasuries.
#3

Thanks for the quick clarification

#4

You’re welcome.