CREDIT STRATEGIES

READING 25 - FIXED INCOME

Credit Analisys: 5 Cs

Covenants - restrictions

Caracter: issuer integrity

Collateral to be claimed

Capital behind

Capacity to pay

Risk Exposures

Spread risk: decline in price relative to risk free bonds, due to spread widening

Lower risk free: higher spread (bad economic conditions - higher default risk Higher risk free: lower spread (good economic conditions - lower default risk

Credit Risk: loss caused by counterparty failure to pay

Default risk: probability of default

Loss severity: loss given default

Modified Duration: sensitiviness to change in free risk rate. Applied to fixed coupon bonds.

Spread Duration: sensitiviness to spread change. Applied to floating coupon bonds.

Empirical Duration

Liquidity Risk: hability to buy/sell quickly and at near fair market value. Bid/Ask spread is wider for HY. Regulatory and risk management greater for HY.

Spread Measures

Z-Spread

OAS-Spread

I-Spread

G-Spread

Difference to the on-the-run Government Bond

Few govern-bonds. Use interpolation

Difference to Swap Fixed Rate (SFR)

Smoother. Many differents maturities avaliable

Zero-Volatility Spread

A single spread is added to implied initial spot curve, to discount the cash flow and result in the current market value

Option Adusted Spread. Require assumption of interest volatility

A single spread is added to each node of the interest tree, to discount the cash flow and result in the current market value

For a potfolio, consider the value weighted average of OAS

Excess Return (XR) = (spread x time) - (Δspread x Duration(spread)) - (time x prob. default x loss severity)