Hi guys
Am on page 249 schweser re Corp bond strategies based on relative value.
Could someone explain why if the yield spread is expected to widen we would chose the lower yield bond?
if you re-read the top paragraph it tells you duration is not a factor. So you are looking at this from a credit risk point of view. When spreads widen it’s a indicator the market is going to give the big F U. So you want to move into lower yield bonds (higher quality) to play defensively and avoid getting smacked in the face by the market.
can someone confirm if the above explanation is correct? when you foresee improving market, you invest in risky bond to out perform, when you predict worsen market condition you usee less risky bond?
But if that is the case, why when yield spread is expected to narrow, you increase spread duration? how is spread duration an indicator of bond quality?
Here is how I’m remembering it. If yield spread widens, either the interest rates have gone up for the worst bond, and thus the worst bond loses value relative to the not bad bond. Or the lower bond yield falls, thus the lower yield bond is worth even more.
If you expect yield spreads to narrow (either the higher rate goes down or the lower rate goes up), you would want to expose yourself to a higher duration to get a higher price appreciation, all things relative. Although I can be very wrong here…my Level 3 comprehension is crap.