[Source - Fixed-Income Active Management: Credit Strategies - Campe Goodman and Oleg Melentyev]
1. Investment-grade bonds have lower credit and default risks than high-yield bonds and are more sensitive to interest rate changes and credit migration, which cause credit spread volatility. The much higher credit loss rate experienced with high-yield bonds results in an emphasis on credit risk and the market value of the position to evaluate high-yield risk.
2. Simplicity is a key advantage of the G-spread: It is easy yo calculate and understand, and different investors usually calcuate it the same way.
3. The G-spread is also useful for estimating yield and price changes for fixed-rate credit securities that do not have optionality
4. For a credit investor, a key advantage of using swap over yields on government bonds is that swap curves may be "smoother" (less disjointed) than government bond yield curves.
5. Excess return can be thought of as the compensation that a bond investor receives for assuming credit-related risks. That is, excess return is the additonal return than an investor receives for purchasing a credit security instead of a security with similar interest-rate sensitivity but with no credit risk.
6. A floater has a modifed duration which is less than its spread duration. The amount of price increase following a narrowing of spreads is determined based on spread duration and will be lower than increase following a decline in equal number of bps
7. SD = 6.7 years; yields decline by .3% => price increases by (-6.7) * (-.003) = .02 %
8. Credit spread volatility is more revelant to IG bonds (as apposed to credit default loss)
9. Spread sensitivity to larger withdrawals by investors from credit funds is an indicator of liquidity. A large withdrawal will likey require fund to sell assets.
10. During periods of financial crisis, correlations move closer to 1. When correlations increase significantly a portfolio that appeared well diversified may be subjected to unexpected price movements.
11. Duration times spread is used to measure credit quality of an existing investment portfolio after a desired credit quality has been established
12. The correlation of expected defaults on the collateral of a CDO affects the relative value between the senior and subordinated tranches; as default correlations increase, the value of mezzanine tranches usually increases relative to the value of senior tranches
13. Investment-grade corporate bonds, the correlation between credit spreads and the risk-free interest rate is negative, not positive
14. One important phenomenon is that key macro factors, such as economic growth defauly rates, and monetary polic, usually have opposite effects on risk-free rates and spreads. For example, a better economic environment generally leads to higher risk-free rates and narrower credit spreads, whereas a weaker economic environment generally results in lower risk-free rates and wider credit spreads.
15. Determining the timing and location of credit cycle weakening is an important top-down relative value consideration for global credit portfolio managers. Regional differences exist in credit cycles, credit quality, sector composition, and market factors.
16. Due to global differences in regulations and laws, such as bankruptcy laws, are a source of risk for investors in international bonds. Non-domestic investors of a particular company’s bond issuances face contractual rights that are less certain than those for domestic investors in the event of debt restructurings.
17. A bond’s empirical duration is often estimated by running a regression of its price returns on changes in a benchmark interest rate.
18. Better-than-expected economic growth is typically associated with narrower credit spreads and lower default rates for high-yield bonds.
19. Spread sensitivity is the effect on credit spreads of large withdrawals by investors from credit funds. Spread sensitivity can be measured as the spread widening (in basis points) divided by the percentage outflow from high-yield funds (funds withdrawn divided by assets under management). A decrease in the spread sensitivity to fund outflows would most likely indicate an increase in liquidity.
20. EM indexes have a higher proportion of commodity producers and banks than developed market indexes have.
21. Global credit managers do use currency swaps and invest in pegged currencies to hedge foreign exchange exposures.
22. When an issuer announces a new corporate bond issue, the issuer’s existing bonds often decline in value and their spreads widen. This dynamic is often explained by market participants as an effect of increased supply. A related reason is that because demand is not perfectly elastic, new issues are often given a price concession to entice borrowers to buy the new bonds. This price concession may result in all of an issuer’s existing bonds repricing based on the new issue’s relatively wider spread. A third reason is that more debt issuance may signal an increase in an issuer’s credit risk.
23. Bid–offer spreads are larger for high-yield bonds than for investment-grade bonds of similar maturity.
24. Investment-grade corporate bonds have meaningful interest rate sensitivity, and therefore, investment-grade portfolio managers usually manage their portfolio durations and yield curve exposures closely. In contrast, high-yield portfolio managers are more likely to focus on credit risk and less likely to focus on interest rate and yield curve dynamics. When default losses are low and credit spreads are relatively tight, however, high-yield bonds tend to behave more like investment-grade bonds—that is, with greater interest rate sensitivity.
25. Credit spreads tend to be negatively correlated with risk-free interest rates. One important reason for this phenomenon is that key macro factors, such as economic growth, default rates, and monetary policy, usually have opposite simultaneous effects on risk-free rates and spreads. For example, a better economic environment generally leads to higher risk-free rates and narrower credit spreads, whereas a weaker economic environment generally results in lower risk-free rates and wider credit spreads. As a result of the typically negative correlation between risk-free rates and credit spreads, changes in risk-free rates tend to generate smaller changes in corporate bond yields than theoretical measures of duration suggest. This reduced effect is even more pronounced for securities with high credit risk and large credit spreads: That is, bonds with comparatively large credit spreads have less sensitivity to interest rate changes than bonds with smaller credit spreads. As a result, the price behavior of bonds with high credit risk often more closely resembles that of equities rather than fixed income.
26. Liquidity in secondary credit markets can be evaluated using a variety of measures, including trading volume, spread sensitivity to fund outflows, and bid–ask spreads.
Trading volume
It is important for individuals to properly understand the liquidity environment in credit markets, as well as its implications. As broker/dealers have reduced their corporate bond holdings, trading volume in credit markets has declined following the 2008–09 global financial crisis.
Spread sensitivity to fund outflows
Another measure used to evaluate liquidity is spread sensitivity to large withdrawals by investors from credit funds. A large withdrawal is likely to require a fund to sell assets.
Bid–ask spreads
Bid–ask spreads can also be used to assess liquidity in credit markets. Generally speaking, bid–ask data should be analyzed cautiously because such information is stable only when markets, in turn, are stable. More volatile market conditions often have a negative effect on bid–ask spreads. This effect is often temporary and suggests that bid–ask levels tend to stabilize after a brief period of volatility.