“During economic prosperity because of reduction in bankruptcies and improvement in overall credit fundamentals of most issuers, credit spread tightens and credit returns relative to Treasuries increase.” Could you please explain this to me? I just cant seem to get a grasp of this… Thank you!
Had to dig into the books again to understand this…
We got to look at things from a total return perspective. Total return comprises of a) Coupons b) Coupon reinvestment c) Price changes from bonds.
When credit spread tightens, this means the Price of the bond rises as the yield decreases towards that of the Treasury securities. Assuming no interest changes, this is exactly what an investor wants…
Cheers!
Yes Sooraj. Is one of the reasons why Fixed Income should use TR Analysis as opposed to just yield pickup perse
credit spreads tighten so dealing with bonds of higher credit quality and narrowere spreads hence very close to T Bonds in quality
Don’t overstate the case: the quality of the bonds may not change at all; the difference is that investors are less risk averse so they require a lower premium (credit spread) for what could, in fact, be the same risk.