Yield curve, recessions and bond maturity (pg 53 Cfa curriculum) I don’t get the logic as to how long duration bonds outperform short duration bonds when yield spread is expected to narrow and widening of the yield spread favoring short duration bonds
I believe it’s because when the yield spread is narrowing, the interest rate is shrinking down towards the benchmark as the risk is getting lower. The required yield to hold this bond is now lower and this increases the bond price. You want to lengthen the duration in this case.
Vice versa for widening yield. When Yield widens and decreases in quality the interest rate will increase away from the benchmark and bond price should go down and you want to shorten the duration.
That’s it in a nutshell:.
Spreads narrow, discount rates go down, value goes up. The longer the duration, the more the value goes up.
Spreads widen, discount rate goes up, value goes down. The shorter the duration, the less the value goes down.