Farro Topic test

[derswap07]

“Joao Gomes, another investment committee member, asks Farro, “I understand that with such low interest rates today, companies are still issuing new debt. Does this situation affect secondary trading?” Farro provides her view on the primary and secondary bond markets. She outlines three strategies HIA is currently using:
Strategy 1: From a tactical perspective, HIA is purchasing more new issues than normal because new issuance volume has declined but new issue spreads have increased.
Strategy 2: Also as a tactical trade, HIA is selling existing holdings as we find liquidity from dealers, and we are using those funds to reposition the portfolio.
Strategy 3: From a strategic perspective, HIA is seeing less issuance of structures, such as bonds, with puts and calls and higher issuance of medium-term notes (MTNs). In our portfolios, we are buying more structures and holding off on purchases of MTNs.”
Can anybody explain the reasoning behind any of these straetegies?
Thanks

 

[cpk123]

St 1: new issue volume decreased = prices increased -> bond yields up - so spreads have increased.
st 2: New issue swaps - rationale for secondary trading:
New issue swaps contribute to secondary turnover. Because of perceived superior liquidity, many portfolio managers prefer to rotate their portfolios gradually into more current and usually larger sized on-the-run issues.
st 3: Structure trades?
Structure trades involve swaps into structures (e.g., callable structures, bullet structures, and putable structures) that are expected to have better performance given expected movements in volatility and the shape of the yield curve.
I also corrected the original title of your post /// fyi ///

 

[derswap07]

Thanks CPK for correcting my typo.
Now the questions on this:
Given current market conditions, which strategy that Farro describes to the investment committee is least likely to have a favorable performance impact on HIA’s portfolios?
Strategy 1
Strategy 2
Strategy 3

 

[Medusa]

The answer is strategy 1. Although you should read this (sorry just trying to watch your back):
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[permabear]

This question confuses me as well. My understanding is that bonds will perform better in high supply. But the answer to this question states that the scarcity of structures will lead to a premium for those issues. Can anyone reconcile this?

 

[McTrump]

Look we need to build a wall and not allow these questions to come in! Am I being unfair here? I do not think so!

 

[MrSmart]

permabear wrote:
This question confuses me as well. My understanding is that bonds will perform better in high supply. But the answer to this question states that the scarcity of structures will lead to a premium for those issues. Can anyone reconcile this?

More supply on a bond will lead to a higher yield, and lower performance if you are holding them, and the opposite is true.
Of course, all else equal.

 

[BldSwtTrs]

cpk123 wrote:
St 1: new issue volume decreased = prices increased -> bond yields up - so spreads have increased.

I don’t understand how can both the price and the yield increase.

 

[hock]

removed

 

[MrSmart]

BldSwtTrs wrote:

cpk123 wrote:
St 1: new issue volume decreased = prices increased -> bond yields up - so spreads have increased.

I don’t understand how can both the price and the yield increase.

It’s a double whammy. Volume dries up, and the new issuances have larger spreads, so you buy those and the price will go on low issuance volume, then you benefit from high yields and take part of the capital gains.

 

[Gersonides]

MrSmart wrote:

BldSwtTrs wrote:

cpk123 wrote:
St 1: new issue volume decreased = prices increased -> bond yields up - so spreads have increased.

I don’t understand how can both the price and the yield increase.

It’s a double whammy. Volume dries up, and the new issuances have larger spreads, so you buy those and the price will go on low issuance volume, then you benefit from high yields and take part of the capital gains.

But this is what is confusing about this question. I agree with your interpretation, and it seems it should have a positive impact on the portfolio, and yet the question asked which strategy would have a negative impact.