Level 1 CFA® Exam:
Volatility of Yield Spreads

Last updated: January 04, 2023

Yield-to-Maturity on Corporate Bond in CFA Exam

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Yield on Corporate Bond
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\(r_{b} = i_{r,f} + E(\Pi) + m + l + s\)

  • \(r_{b}\) - yield on corporate bond
  • \(i_{r,f}\) - real risk-free interest rate
  • \(E(\Pi)\) - expected inflation rate
  • \(m\) - maturity premium
  • \(l\) - liquidity premium
  • \(s\) - credit spread
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Yield Spread (Relative to Default-Free Bond)
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\(r = l + s\)

  • \(r\) - yield spread
  • \(l\) - liquidity premium
  • \(s\) - credit spread
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Level 1 CFA Exam: Volatility of Yield Spreads

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Factors that impact the level and volatility of yield spreads:

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Note that the spreads for higher-quality bonds are less volatile and change less as a result of the above-mentioned factors.

If we want to quantify the impact of the change in a spread on the bond price, we can use the following formulas:

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Price Impact (Due to Small Spread Changes)
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\(PI \approx -ModD\times \Delta s\)

  • \(PI\) - price impact
  • \(ModD\) - modified duration
  • \(\Delta s\) - spread change
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Price Impact (Due to Large Spread Changes)
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\(PI \approx -(ModD\times \Delta s) + 0.5\times C\times (\Delta s)^{2}\)

  • \(PI\) - price impact
  • \(ModD\) - modified duration
  • \(\Delta s\) - spread change
  • \(C\) - convexity
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Level 1 CFA Exam Takeaways: Volatility of Yield Spreads

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  1. Yield-to-maturity on a corporate bond depends on government benchmark yield and spread over the benchmark.
  2. Factors that impact the level and volatility of yield spreads are: credit cycle, broader economic conditions, financial market performance, broker-dealers' willingness to provide liquidity in the market, and bond market supply and demand.
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