Static credit spread curve - lower the portfolio's avg. credit rating

CFA Level III Fixed Income
#1

Hello guys,

I’m reading FI static credit spread curve strategies - lower the portfolio’s average credit rating.
From the CFA official textbook, it says that
The portfolio manager can lower the portfolio’s average credit rating to increase the expected excess return on the portfolio.
Because of the following formula:
E [ExcessSpread] ≈ Spread0 − (EffSpreadDur⨯ΔSpread) − (POD *LGD))
if Spread, POD, and LGD remain stable

What I don’t understand is that, if the portfolio’s average credit rating is lowered, shouldn’t the delta spread increase and thus lead to a decrease in E[ExcessSpread]?

#2

The spread should increase.

What makes you think that ∆spread should increase?

#3

So you meant that Spread0 would increase and ΔSpread wouldn’t increase?
I think I’m just confused by the text “generate excess return … when Spread, POD, and LGD remain stable”…

截圖 2022-08-11 上午9.53.34
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#4

If the spread stays stable, then ∆spread = 0. For those bonds.

Lower quality bonds will have a higher spread than higher quality bonds.

#5

Thanks a million!

#6

My pleasure.