CFA Fixed Income

Structured Financial Investments

Structured finance represents an alternative to corporate bonds in the credit portfolio. They offer some combination of: Higher yield and expected return. Tailored risk exposure through multiple tranches with varying levels of risk ranging from first tranche (often AAA) to mezzanine last tranche, which could be below investment grade and offer higher expected return. Exposure … Read more

CFA Fixed Income

International Credit Portfolios

Investing in multiple markets and currencies offers opportunity and risks. But even investors who restrict holdings to one country should realize the bond issuers in that country may generate significant revenue and profit in other countries, exposing the investor to global risks. International investing offers greater relative value opportunities. For instance, new issuance of corporate … Read more

CFA Fixed Income

Credit Strategy Approaches

Credit strategies normally establish return and risk parameters. A credit strategy is typically designed to achieve a constrained objective. There are two important credit strategy approaches: a bottom up approach and a top down approach. Bottom Up Approach The bottom-up approach to credit strategy is sometimes called a “security selection” strategy. The key feature of … Read more

CFA Fixed Income

Credit Spread Measures

A simple way to calculate a credit spread is to subtract the yield on a security with little or no credit risk (benchmark bond) from the yield on a credit security with a similar duration. This measure is called the benchmark spread. Typically, the benchmark bond is an on-the-run government bond. An on-the-run bond is … Read more

CFA Fixed Income

Investment Grade and High Yield Bond Portfolios

A credit portfolio consists primarily of securities for which credit risk is an important consideration. The credit market is the component of the fixed-income market that includes both publicly traded debt securities (such as corporate bonds, sovereign and non-sovereign government bonds, supranational bonds, and commercial paper) and non-publicly traded instruments (such as loans and privately … Read more

CFA Fixed Income

Butterfly and Condor Trades

Butterfly trades are a leveraged way to capture value when curvature changes. They involve taking a long and offsetting short position in the bullet and offsetting barbell. The short position funds the long position so no investor capital is required. The long and short duration cancel each other for a 0 net duration. Butterfly trades profit … Read more

CFA Fixed Income

Adjusting Convexity

It is beneficial to have greater convexity when large changes in rates are expected. The convexity will magnify value gain when rates decrease and cushion price loss when rates increase. However, there is likely to be a cost in the form of lower yield (and income from the portfolio). Barbell vs. Bullet Structure To increase … Read more

CFA Fixed Income

Strategies for Changes in Market Level, Slope, or Curvature

Investors often hold individualized expectations about the yield curve that they generate from economic analysis, data mining exercises, following monetary policy and central bank actions, or other techniques. To the extent that investors position their portfolios based on these expectations, they are disagreeing with the forward expectations embedded in the yield curve. If their expectations … Read more

CFA Fixed Income

Strategies under Assumptions of a Stable Yield Curve

Buy and hold: In an upward sloping curve, extend maturity (and therefore duration) to earn a higher yield and expected return. Another advantage of this strategy will be low turnover and transaction costs. This strategy is not necessarily passive if it involves selecting a duration or exposure to points on the yield curve (where rates are … Read more

CFA Fixed Income

Major Types of Yield Curve Strategies

At the most basic level, fixed-income portfolio returns come either from yield (typically defined by the cash flows associated with the portfolio) or from price change over the measurement interval. In the current low interest rate environment, significant yield accumulation is a difficult challenge, so managers use various techniques to enhance portfolio yield. The two … Read more