Spread risk Q

To invest in MBS, the managers hedge the interest risk but not the spread risk. Here are two questions:

1, Why not hedge the spread risk? 2, How to measure spread risk? If it’s spread duration, does it means that spread duration is not matched?

if you hedge the spread risk - you can go only one way. Either the spread widens - you hedge for that, if the spread narrows - you lose.

Spread Narrows - your portfolio gains - but you lose on your hedging contract.

So Spread Risk is not hedged.

You buy MBS when low value - i.e. when Spreads are wide.

Sell MBS when HIGH value - i.e. when Spreads are NARROW.

Invest in MBS when initial OAS is HIGH - that is Spreads are WIDE - and it is low priced.

I think the measure of Spread that they use in the MBS chapter is OAS … since there are not option free bonds.

CPK, so what is difference between MBS and a corporation bond? we some time should hedge spread risk of corp bond ?

^ whoa… that should be basic knowledge for a L3 candidate

it’s not like Vietnam has a huge MBS market

Thanks guys, actually, Vietnam has no MBS completely and unfotunately, i will take the exam like you…

the question here is why he should not hedge spread risk when invest in MBS (while he do hedge when invests in corp bond ). However, in both case, he give up up side potential…(when spread narrow…)

Tulk: i do search and see 2 threats in 2008 and 2009, they also have no answer…

and the answer is that, do what CFAI says, and they say, do not hedge …

Thank you guys. It’s a simple question, not to challenge the curriculum.:wink:

Just curious, many things in L3 are mean-reverting, but yield curve is not mean-reverting?

hi all

my 2 cents: You actually buy MBS because of the spread (or higher yield) - so why hedge the spread?

hi all

my 2 cents: You actually buy MBS because of the spread (or higher yield) - so why hedge the spread?

Is that same as " hey guy, i bought ABC stock because of low price, why should i hedge the long position ???" ?

whatever, forget it…

If the spread of MBS is expected to widen, the investors can sell them. But who will buy them if the spread is going to be wider? Or just falling from the cliff?

it’s not the same. because when you buy MBS and hedge against interest rate move w/ 2 bond hedge, are playing for spread or relative returns. which is why it is in that part of the reading - next to relative value methodologies.

if you are long a stock you are long. you would have to be long 1 stock of a pharma company and short the index against it to create some kind of paralell argument to the MBS.

and the reason why you don’t hedge spread, is because that is where you make the $$$…

Hey man, some one who expects narrower…:))

I just thinking about what factor will impact on spread of MBS (something like subprime MBS crisis)…I can not say what it is but it is exactly difference with factors impact on corp bond…