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Try again, because this is not your best table. And that is saying something because your tables are
awful.
Relative value analysis is simple taking a look at which sectors you think will outperform others,
which issuers you think will outperform others, which structures you think will out perform
others, etc.
Historical analysis is a good way to determine if, for example, credit spreads have deviated from
their long-term trend levels.
It is also useful to analyze the overall level of market liquidity in order to determine which bonds
will outperform others (see 22c).
That's a bit better, but what is the ideal method for conducting Classic Relative-Value Analysis?
Top-down approach:
Bottom-up approach:
These seem a lot like the descriptions of the Top-down and Bottom-up approaches in 17e and 24v.
How do short-term economic fluctuations influence prices and spreads in the primary market for
corporate bonds?
In recessions, default risk increases and spreads widen, so risky bonds significantly
underperform risk-free bonds.
By contrast, economic growth causes spreads to narrow and risky bonds significantly
outperform risk-free bonds.
As interest rates drop, corporate issuers may take advantage of this by obtaining debt financing
at lower rates.
An large Increases in the number of new corporate bond issues will cause credit spreads to
narrow.
This is because fixed-income traders like the fact that a flood of new issuances serves to valuate
valuations in the secondary market.
What are the secular (ie. long-term) changes to the primary market for corporate bonds?
As issuers have sought to lower their cost of capital under various yield curve/spread scenarios
and match assets to liabilities, there have been significant changes to bond markets since the
80s/90s:
Structured notes and swap products are now common
High-yield corporate sector is now an accepted asset class
Global origination is now common for US Agencies, large corporates and supra-nationals
Global credit bond market is much more homogeneous
Bullet maturities (not callable, putable, or sinkable) and medium term notes are now
dominant and longer-term notes with call/put/sinking features are much less common
Callable issues still dominate the high-yield segment, but this situation is expected to
change as credit quality improves with lower interest financing and refinancing
In all but the high-yield market, intermediate-term bullets dominate the corporate bond
market
How are portfolio management decisions influenced by, say, short-term liquidity needs?
Some fixed-income managers are willing to give up additional return by investing in issues that
possess greater liquidity such as larger-sized corporate issues (>$1bn) and government issues.
By contrast, other managers are willing sacrifice liquidity for issues which offer a greater yield
such as smaller-sized issues and private placements.
Liquidity will ebb and flow with factors such as the economic cycle, credit cycle, yield curve
shape, supply, seasonality and market shocks such as a wave of defaults.
However, the overall trend is towards greater liquidity as new technologies are adopted and
markets become truly global as evidenced by decreasing bid/ask spreads - especially for large,
well-known corporate issuers.
2) Credit-upside trades
3) Credit-defense trades
The manager is seeking to take advantage of sectors that are expected to outperform on a total
return basis.
Often based on macroeconomic analysis and economic cycle.
For example, a manager may want to rotate out of bonds issued by cyclical firms as the
economy begins to slow.
5) Structure trades
Trading into structures (callable, bullet, and put) that are expected to outperform due to
movement in volatility and yield curve shape
High-coupon callables do poorly when yields drop
Stable yield curve makes high-quality callables more attractive than high-quality bullets
Putables do poorly when yields drop because investors had decided to sacrifice yield for
protection against higher rates
Callables underperform bullets during high volatility & vice versa.
PM wants to alter portfolio duration to be aligned with anticipated yield curve changes
In practice, such adjustments are done via the more liquid Treasuries market, but can be done
via credit market
Also done in anticipation of changes in credit/spread curve
2) Story Disagreements
3) Buy-and-Hold
4) Seasonality
Relative Valuation
Description
Methodologies
Analysis
Total Return
Analysis
Primary Market
Analysis
Liquidity Analysis
Spread Analysis
- Nominal spread
- Static (Z) spread
- Option-Adjusted spread (Note: OAS
does NOT account for default risk and is
therefore inappropriate for analyzing
speculative-grade (high-yield) bonds.
Structural Analysis Considers the relative value of bond
based on their structure.
Credit Curve
Analysis
Credit Analysis
Attempts to predict credit upgrades and Managers with superior credit analysis
downgrades.
skills will be highly rewarded in the bond
market.
Sector Analysis
See 22d
See 22d