R21: FI Active Management

Question 1

Difference between IG and HY with regards to empirical duration?

Answer 1

IG: empirical = effective
HY: empirical much lower (may be negative)

Question 2

What’s empirical duration?

Answer 2

Regress actual change in price versus change in benchmark yield.

The higher the OAS, the lower the empirical duration.

Aaaa-Baa positive, Ba and B = 0, Caa negative.

For every credit rating, less effective than effective duration.

Question 3

OAS vs Z-spread for callable vs putable?

Answer 3

Callable: positive option cost, OAS lower
Putable: negative option cost, OAS higher

Question 4

Covered bonds vs CDOs?

Answer 4

Similar but covered bonds’ assets remain on issuer’s BS so less risky.

Question 5

CDOs, what happens if the correlation of expected defaults increase?

Answer 5

The mezzanine tranche will increase in relative value compared with the equity and senior tranches.

Question 6

Spread duration vs effective duration

Answer 6

Same unless there are treasuries in portfolio that causes spread duration to differ.