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Credit strategies (Credit spread measures (G spread: spread against govt…
Credit strategies
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Credit spread measures
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OAS : constant spread added to forward rate to equal price (compared with embedded options). Most appropriate for bonds portfolio
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Credit strategy approach
Bottom up approach
- Divide credit universe
- bottom-up relative analysis (expected excess return)
- Other considerations: structure, features, issuance date, supply, size
PC: consider what risks are important
- MV for default losses
- Spread duration for spread changes
Top down approach
Focus on:
- macro factors
- credit quality (influenced by credit cycle and expectations, economic conditions)
Assess:
- Avg credit quality
- Avg OAS
- Avg: spread duration
- Duration times spread (DTS): accounts for OAS and SD
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Tail risk
Assessing tail risk
- Scenario analysis
- Historical & hypothetical scenario analysis
- Correlations in scenario analysis
Managing tail risk
- Diversification
- Tail risk hedges (CDS/options)
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Structured instruments
- backed by collateral (higher returns through tranching)
- Can improve diversification
RMBS
- Liquid
- exposure to real estate
- exposure to IR volatility (Buy MBS in stable [sell convexity]
ABS
- auto/credit/student loans
-liquid
CDO
- collateral using coporate loans/bonds
Covered bonds
- debt backed by pool of assets
- lower credit risk/lower yield