Hey everyone, I don’t think this is an overly difficult part of the curriculum, I just can’t seem to get my head around it. What is spread duration exactly? I know that a portfolio of treasuries has zero spread duration, a corporate portfolio has a spread duration equal to the effective duration of the portfolio, and a portfolio with both treasuries and corporates will have a spread duration of less than the effective duration. Is literally all I need to know that corporate bonds have a spread duration= to the effective duration? And that if there is a portfolio with both corporates and treasuries, I would just go about calculating portfolio duration the same way as before, except using a zero value for the weight of the portfolio that is made up of treasuries? Just seems an odd notion to me I guess… Thanks
All I know is spread duration is the change in spread over the change in rates and is used as a measure of credit risk. But, spreads can change even without changes in interest rates due to market perception of a particular sector/company.
Yeah, I suppose it was just a complicated way of saying that corporate bond duration is a function of more than just interest rates and time horizon. I’ll wing it I guess. Thanks
This really tripped me up on the CFAI 2011 Mock (spoiler alert) Question 33, regarding tracking error: I don’t understand- why is there more tracking error from the different contributions of spread duration? Corporates have a different spread duration in the portfolio from the index. But Treasuries have a larger difference in the actual duration. Why isn’t this difference in duration more important than the difference in spread duration? Thanks for any illumination on this!
I believe spread duration is more about credit risk.
That’s what I thought too. So I was confused to see that this was considered the biggest risk re tracking error. Wouldn’t tracking error be attributed to regular duration?
I don’t understand this either to be honest. The takeaway for me was just focus on spread duration if this comes up. But logically, one would think that since the duration difference in the treasuries is larger than the sprd duration in corporates, that treasuries would have the larger tracking error (treasuries can’t have spread duration). I could understand the answer if the spread duration contribution was larger than the duration mismatch between the benchmark, or if we were given weights for each asset so you could calculate the “duration contribution” for treasuries and determine it is less than the spread duration contribution that was given for corporates, but it’s not. Dirty question.
markCFAIL Wrote: ------------------------------------------------------- > I don’t understand this either to be honest. The > takeaway for me was just focus on spread duration > if this comes up. > > But logically, one would think that since the > duration difference in the treasuries is larger > than the sprd duration in corporates, that > treasuries would have the larger tracking error > (treasuries can’t have spread duration). > > I could understand the answer if the spread > duration contribution was larger than the duration > mismatch between the benchmark, or if we were > given weights for each asset so you could > calculate the “duration contribution” for > treasuries and determine it is less than the > spread duration contribution that was given for > corporates, but it’s not. > > Dirty question. There’s an EOC that is almost exactly the same explaining it. Having said that I still got it wrong.
I don’t know if this helps , but there is an errata from CFA about Mock 2011 , and I quote: Level III • Mock Exam: Question 33 has been corrected to state: Based on the data in Exhibit 2, Mont’s positioning of the portfolio would suggest that the spread sector that poses the most tracking error relative to the benchmark is … and they highlight the word “spread” in red
That’s worth another point then. Hello 85%.
That absolutely helps.
spread duration is just duration for fixed rates. this is a measure used in my experience with floating rate debt.
cookthebooks Wrote: ------------------------------------------------------- > spread duration is just duration for fixed rates. > this is a measure used in my experience with > floating rate debt. Spread duration is duration for sectors that have credit risk according to the book. Don’t use industry practice. Spread duration is completely wrong to industry practice. Kind of like credit spread puts/call. I couldn’t figure out why I kept getting them wrong until I realized that CFA texts are opposite to industry practice to make it “easier to understand.”
i shouldve pointed out the assumption of credit risk, my fault and im sorry if i confused anyone.
Errata. That totally makes sense now. Thank you!