Why choose B, not A?
Please post the question, makes it easier for people to help you.
Spread curve for US corporate bonds indicate that the average spread of five-year BB bonds exceeds the average spread two-year BB bonds by +90 bps. Someone expects the differences btw average credit spreads for these two sector to narrow to +50 bps.
The answer is to underweight 2-year BB & overweight 5-year BB.
if credit spreads narrow (improved economy), why we are not overweighting HY bonds?
both are rated BB so I’m not sure if HY vs IG comparison works here.
in addition, the 5-year BB bond most likely has higher duration and therefore you should overweight it in anticipation of falling yields due to narrowing spreads.
You are quite right that HY/IG does not play a role.
may I know why does the longer-maturity(longer-duration) shall be preferred in condition of narrowing credit spread or falling interest?
I have looked through the chapter again, only to find that spread duration might be relevant, however, which is not mentioned in this case at all…
When interest rates are decreasing or expected to fall, you need to increase portfolio duration.
% change in value = -D x change in yield
So if yields are expected to fall, increase duration.
Thank you, na27.
i am so dumb just to realized this is fundamentally critical in duration management.