Credit spread risk is the risk of greater expected loss due to changes in credit conditions as a result of macroeconomic, market, and/or issuer-related factors. Macroeconomic Factors Market Factors Issuer-Specific Factors The Price Impact of Spread Changes
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Fixed-income investors face credit risk, a form of performance risk in a contractual relationship. A borrower that fails to meet its promised interest and/or principal payment obligations under a bond or loan contract is said to be in default. A fixed-income investor seeks compensation for the expected economic loss under a potential borrower default over the…
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The approaches taken so far to estimate duration and convexity statistics using mathematical formulas is often referred to as analytical duration; the measures we have covered are summarised as follows: In practice, there is another important type of duration: Fixed-income professionals often use historical data in statistical models that incorporate various factors affecting bond prices to…
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Key rate duration (or partial duration) is a measure of a bond’s sensitivity to a change in the benchmark yield at a specific maturity. Such a measure is important to isolate the price responses of bonds to changes in the rates of key maturities on the benchmark yield curve. Key rate durations define a security’s price…
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Just as with yield-based interest rate risk measures, effective duration and effective convexity can be used to estimate the percentage change in a bond’s full price for a given shift in the benchmark yield curve (∆Curve),
Yield duration and convexity assume a bond’s cash flows are certain. However, if a bond has contingency features, such as embedded options, as with a callable (or puttable) bond, then future cash flows are uncertain since option exercise depends on the level of market interest rates relative to coupon interest being paid (or received). For example, the…
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There are two ways to calculate the duration and convexity of a bond portfolio:
Money convexity (MoneyCon) captures the second-order effect in currency terms and is the annual convexity multiplied by the full price, Similar to estimating the percentage change in a bond’s full price, MoneyDur and MoneyCon are combined to achieve a more accurate, thus less risky, estimate of the change in a bond’s full price,
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Convexity is a complementary risk metric that measures the second-order (non-linear) effect of yield changes on price for an option-free fixed-rate bond. The true relationship between a bond’s price and its yield-to-maturity is the curved (convex) line that shows the actual bond price given its market discount rate. Duration (i.e., money duration) estimates the change in…
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