Break even analysis

CFA Level III Fixed Income
#1

CFAI Sample says: (Yield Euro - Yield US) / DUR US Schweser Book 3 p. 94 says (Yield foreign - Yield dom.) / DUR for. Which is the right denominator? Foreign duration or domestic? Thanks!

#2

Higher duration

#3

Thanks. Is it that simple? Country does not matter?

#4

Chose US of A ALWAYS!!! YEAAAAA

#5

Currency movememt doesn’t matter.

#6

comp_sci_kid Wrote: ------------------------------------------------------- > Chose US of A ALWAYS!!! YEAAAAA US = domestic ? Again, in Schweser they divide by foreign DUR, in CFAI Sample 3, Q 18 they divide by US DUR (=domestic).

#7

it is joke :(, Always pick highest duration unless specified otherise)

#8

Thanks!

#9

isnt the formula spread = dur * w

#10

comp_sci_kid Wrote: ------------------------------------------------------- > it is joke :(, Always pick highest duration unless > specified otherise) Is this also a joke?

#11

The formula for duration being (change in bond price/change in bond yield), now to calculate breakeven yield spread why are we dividing the yield difference with the duration? Shouldnt this be price difference/duration? My issue is with the numerator.

#12

numerator = price difference

denominator = duration = price / change in yield = price / spread

now price / (price/spread) = spread

so formula is right !

#13

Thanks cpk123 for your reply, but I am still not clear.

if, Duration = change in price / change in yield

so, change in yield (or breakeven yield spread here ) = change in price (or price difference) / duration

the schweser text gives the same formula, but in the example it puts the yield difference (difference in yields between the foreign and local bond) instead of price difference as the numerator. The text seems to assume that yield difference is equal to price difference, which doesnt hold true.

#14

when spread increases - price change decreases.

remember for bonds - an increase in yield = drop in price.

and for bonds - once you know yield you also know the price.

I am right now not at this place… when I get around to it, I might have a better idea. Can you post a page number, study session information where this is stated, so I can get back with further information?

Thanks,

#15

Thanks.

The example is in Schweser Book 3 p. 94.

I do understand the effect of yield change on bond prices. But when we say that 1% increase in yield = 1% decrease in price, we are assuming Duration =1, which is clearly not the case here. The durations of both the bonds involved are more than 1.

#16

which is why the most conservative case - divide the change in nominal return by the HIGHER of the TWO DURATIONS. That gives you a smaller number - to get the change in yield that would wipe out any price advantage that the bond might have.

#17

formula:

Change in price= - duration * yield change

here u replace yield change with break even yield change coz u r trying to discern the change in price which will make the investor indifferent between the two bonds.

then u assume that change in price due to widening of spread would be equal to yield difference btn two. U use higher duration from the two bonds in question.

#18

thanks rahuls. I understand everything, except, “then u assume that change in price due to widening of spread would be equal to yield difference btn two”. Why would you assume this and ignore the ‘duration’ altogether?

#19

U assume that keeping duration constant or only to see the effect due to widening of spread. So wateva is the difference in yield would be equal to price change.

You use high duration to see the minimal change required which wipes away yield advantage unless stated otherwise.

#20

Usually: Price Change in % = Duration * Yield Change

Here: Yield Spread of the two bonds = Duration(i) * Yield Change(i)

Which duration to choose? It depends on what the question is asking for.

1, It’s usualy holding the other duration unchanged.(no currency value change, either) 2, The spread should be widening.(higher yield gets higher; lower yield gets lower) 3, Choose longer Duration if not specified.