Breakeven spread analysis Q

but the way Yield is being used here - is a NUMBER. Not Total Return that you are talking about. It is the YTM of the Bond in question. There is a 300 BPS yield difference (or thereabouts between the bonds).Think just yield being a Interest rate number….
that is all they are trying to make up. Not the return on the bonds…
They are also not talking of a country wide “yield disadvantage” in this analysis… that Japanese bonds are more expensive because their yields are lower and so on. That is not it, at least per my understanding.
 
Yes, the yield is lower on the JPY, but we are trying to figure out how to offset this yield disadvantage through price increases, which relate to duration and the JPY yield curve - so to offset the gain that the U.S. bond has in terms of yield (and remember, Tuluku is correct in that YTM does not account for a.) coupons or b.) price movements, it simply relies on YTM which assumes par payoff - while total return does capture both of these), the JPY yields must decrease, holding all else constant. The price will increase on the JPY bond if yields decrease. The price increase will offset the yield advantage.
Does this make more sense?
 
It seems that the total return doesn’t tell the whole story.
Now the question is more general, how the formula for the breakeven analysis is derived. My mind doesn’t work well now, but I believe this is a good question to think of.
 
Im also tired and throwing in the towel, but as a good check on your theory CPK – that the “spread” refers to the 300 bps between the two… would be to check on both bonds the amount you calculate as the breakeven to see if it works. Since by saying the spread must “widen” by “x amount” … that would imply either the JPY or the USD bond could move, so long as the resulting difference in spread is the same.
However i bet if you apply the number which I think was like 8.09 bps –you will only get the necessary offsetting yield using one of the bond’s durations, not both. This is proof to me that the spread widening they are referring to is not the difference between JPY and USD bonds. Now im head-tired and going to sleep. Will pick this up tomm. This concept is pissing me off because it’s really rather easy but its these typical CFAI nitpicking terminology choices that make it unnecessarily difficult.
 
SCH says
Breakeven analysis involves determining the widening in the spread between two bonds that will make their total returns (i.e., coupon plus capital gain or loss) equivalent over a given period.
Japan 10yr note yield - 1.67 duration - 9.12
US 10yr note yield - 4.62 duration - 7.79
Investor invested in US will gain additional yield in one quarter 4.62-1.67 = 2.95 / 4 = 0.74 with no changes in spreads/yield curve over the course of 3 months you will have 0.74% more in total return based solely on income
Now Japanese bond to generate same return, price has to appreciate by 0.74% to make the additional gain made in US. Since int rate & price move opposite. Yield has to decrease in Japan in order to give a price rise of 0.74%. How much decrease in yield will be decided by the duration
So we need = 0.74 / 9.12 = 0.0809 % or 8.09 bps decrease in Japan to give a price rise of 0.74% for a quarter to make up to additional gain made in US bonds.
 
markCFAIL:
Yes the question doesn’t specify in which country yield should increase or decrease. Had it asked how much spread has to widen in US to give away additional yield for a quarter this would have been more appropriate.
Take it conversely. If US bonds are giving an yield adv of 0.74% for a quarter if the price goes down here by the same % we would not have any advantage of investing in US bonds. In US yield has to increase (i.e. SPREAD HAS TO WIDEN keeping Japan yield constant) in order to give a price loss of 0.74%.
We use highest duration to determine minimum change in spread. Also without considering CURRENCY MOVEMENTS. I just read some where, one of the sch ques also incorporated currency movement while analysing break even yield.
Hope my understanding is right in this context. Let me know if anything is missed.
 
Borrowed from an old post: Few ques
If possible give brief explanation of how your ans will ensure breakeven (offset yield advantage of one bond over another)
1) Mary Brickland, CFA, is analyzing two different domestic bonds. Bond A has the longer modified duration at 9.50 with a yield of 9.12%. Bond B has a modified duration of 7.30 and a yield of 7.80%. Brickland has an investment-holding period of one year and expects a favorable credit quality change for Bond B to increase its market value during this time frame. If Brickland buys Bond B, what is the required basis point change in the spread (in terms of the required yield on Bond B) to offset Bond A’s yield advantage?
A) 13.89474 bp due to a decline in the yield.
B) 14.72190 bp due to an increase in the yield.
C) 18.08219 bp due to a decline in the yield.
2) Jack Hopper, CFA, manages a domestic bond portfolio and is evaluating two bonds. Bond A has a yield of 5.60% and a modified duration of 8.15. Bond B has a yield of 6.45% and a modified duration of 4.50. Hopper can realize a yield gain of 85 basis points with Bond B if there are no offsetting changes in the relative prices of the two bonds. Hopper has an expected holding period of six months. The breakeven change in the basis point (bp) spread due to a change in the yield on bond A is:
A) 10.42945 bp due to a decline in the yield.
B) 5.21472 bp, due to a decline in the yield.
C) 5.21472 bp due to an increase in the yield.
Similar to 1 but made some changes.
3) Mary Brickland, CFA, is analyzing two different domestic bonds. Bond A has the longer modified duration at 9.50 with a yield of 9.12%. Bond B has a modified duration of 7.30 and a yield of 7.80%. Brickland has an investment-holding period of one year. What is the required basis point change in the spread needed to breakeven.
A) 13.89474 bp increase in A
B) 13.89474 bp decrease in B
C) 18.08219 bp decrease in B
 
1) 1.32 / 7.3 = 18.08219 bps decline in B … since Bond B is owned (C)
2) A is owned. 0.425 / 8.15 = 5.21472 decline in A’s yield to compensate (so it’s price will increase). (B)
3) 1.32 / 9.5 = 13.89473 increase in A (A)
 
great..You guys are prepared for break even yield questions…
Any views if we were to incorporate currency movement as well in break even ques…how the question would be like & how would we deal with it….
 
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