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)