Pg 91 book 4 question 15…
Talks abt spreads increasing (Prices falling) with a higher issuance of A Corp bonds… This is counter to what is mentioned in the text (Pg69… Heavy supply compresses spreads-Prices rise)
Any thoughts???
It is not a contradiction . It is correct. Investors look for the lowest price while issuers look for prices close to 100 par . If there is oversupply , obviously it would be a buyers market i.e. tilted in favor of investors. prices would drop until issuers can no longer afford it.
Ok – did you read page 69 like he mentioned? I tend to agree this would be a contradiction. Intuition would tell me that heavy supply would cause spreads to rise as you mentioned, but the book does clearly state that in the primary issuance market heavy supply is associated with narrowing spreads, and it lists the reason as “validation of current secondary issue valuation levels”.
Heavy bidding in secondary market -> narrow spreads -> issuers incentivized to sell debt in primary market (lower yields).
Its fantastic that all of us can pick one side to argue, but nobody is answering the fkng question he asked which is why there is a contradiction. I think we all get the concept of primary market validation of secondary market valuations resulting in narrower spreads, but that does not explain why one page says an increase in single A issuances causes increased spreads.
investment grade vs. A-grade?
not sure if they are different credit qualities makes any difference at all.
I have sent a note to the CFAI erratum team to explain this “contradiction”. When I hear back from them, I’ll post again.
the book states that increases in new issues are generally associated with market spread contraction. this does not mean that the market spread contracts BECAUSE of increases in new issues - it means that when market spreads contract, companies want to issue more debt.The widening of spreads begets the issueing of debt, not the other way around.
If you think about it this makes sense, if spreads contract, bonds within that credit quality are relatively more expensive. This is when an issuer would want to issue their bonds because they would get more money.
Once issuers start to overcrowd the market in a particular credit level, spreads will begin to widen and they will not want to issue bonds anymore.
The superior performance of new issues has become a self-fulfilling prophecy because of the demand, liquidity and herding behaviors. The portfolio manager here may be a “contrarian”, and he believes the supply will make the spread wider, thus create a buying opportunity. Once the issuance is done, the spread of single-A paper will tighten.
Did the portfolio manager pass LIII exam, I doubt it.