I dont seem to get my head around the example given on pages 29 and 30 of the CFA Curriculum Vol 5.
The example illustrates the use of the swap spread in fixed income pricing and is used to price a corporate bond.
In the example the treasury yield for the maturity of the corporate bond is calculated by interpolation and is 0.586%. Then it is stated that the swap spread is 0.918%.
The yield of the corporate bond is calculated as Treasury yield + Swap Spread = 0.586% + 0.918% = 1.504% which is then used for discounting the cash flows and pricing the corporate bond.
I don’t get how the yield for the corporate bond calculated this way reflects the credit and liquditiy risk of the bond.
My understanding is that swap spread = swap rate - on the run Treasury yield
So Treasury yield + Swap Spread should be equal to Treasury yield + (swap rate - on the run Treasury yield) . Which basically just leaves me with the swap rate. However, disocunting the corporate bond with the swap rate doesen’t seem right.
Then it is also stated that the swap spread helps to identify time value, credit and liquditiy components of a bond’s YTM. The higher the swap spread, the higher the return that investors require for credit and/or liquidity risk.
How is this the case? If the swap spread increases for a given swap rate, the on the run treasury yield needs to decrease. But a decrease in yield would mean, that the investor is getting compensated less for the risks of the treasury bond.