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Corporate spread durations have to do with the response of the price of a corporate bond to various economic conditions over the life of the bond. In this sense, it is focused on the price sensitivity of the bond as it relates to such factors as changes in the marketplace and shifts in Treasury spreads as they relate to the bond option. Projecting it is one of the common tasks that many investors and brokers who deal in bond issues will investigate very closely before making a bond purchase.
A corporate spread, as it relates to a bond, has an impact on the amount of cash flow that may be received by the investor who holds the bond option. Depending on the shifts in various factors, investors may need to rethink if and how they will exercise their options in relation to the corporate bonds. If the corporate spread duration indicates that changes in the market price merit the action, the investor may chose to execute the bond issue, if this is an option with the structure of the bond.
Bond issuers also watch this response, as it can affect whether the bond is allowed to reach maturity or if the bond should be called at an earlier point in time that is allowed by the terms and conditions associated with the bond. For example, if the corporate spread duration is such that conditions cause the price of the bond to rise significantly, the company issuing the bond may choose to call the bonds early, pay them off, and create a new bond issue. If it indicates the bond price is rising according to projections and there are no major shifts in the market, however, the bond is likely to remain intact until the point of maturity.
Tracking this response is based on the utilization of a 100 basis point change in corporate spreads over LIBOR. If all factors remain more or less within projections, then bond holders and issuers typically will not feel the need to take any action and the bond will continue to progress toward maturity. A spread over LIBOR that indicates economic changes that alter the climate and change the basic assumptions of market performance as they relate to the bond issue, however, may indicate the need for action sooner rather than later.
@miriam98 - I think before anyone buys corporate bonds they need to research and compare the yields between those bonds and comparable government bonds. Analysts call this difference corporate credit spreads.
Sometimes the numbers can be very high, something on the order of 20%, and at other times they can be much lower.
I believe that if we’re in a downturn that’s causing credit spreads to nose dive, then it might be better just to buy the government bonds for the added safety they give you.
@MrMoody - I agree. I think that people often buy corporate bonds without asking some fundamental questions about the nature of the risk they’re incurring.
They’re attracted to higher yields and usually brush off the technical questions or leave them to the market analysts to answer. However, I don’t think that you need to be an analyst in order to ask some very basic questions about corporate bonds.
For example, just ask how much debt the company is carrying compared to the value of its assets. If they’re servicing a huge amount of debt compared to assets, I think you’d better avoid investing in them altogether.
All corporate bonds carry risk, but there is no point plunging into an abyss from the start, in my opinion.
Corporate bonds by definition are higher risk investments than their government counterparts; corporate spread duration is one of those inherent risks in these bonds.
It’s something you have to take into account, and the fact that they respond to market gyrations almost makes them like stocks, in my opinion. They differ from stocks, of course, in that they have maturity dates with payout amounts.
I bought a corporate bond some years ago and the company that issued the bond eventually defaulted, making my paper worthless. I should have heeded the warning signs, but at the time, I just thought a bond is a bond.
Yes, I understood that the corporate bond had higher risk than a government
bond but mostly I just gave lip service to the idea that I understood what I was getting into.
I believe that anyone trading corporate bonds should do so with a watchful eye on the bond markets and at least some understanding of what causes various stresses on the bonds.