Page 42 - FINAL CFA SLIDES DECEMBER 2018 DAY 15

LOS 55.i: Describe factors that influence the Session Unit 16:
level and volatility of yield spreads., p138
55. Fundamentals of Credit Analysis

Yield spreads on corporate bonds are affected primarily by 5 interrelated factors:

1. Credit cycle -At the top of the credit cycle, the bond market perceives low credit risk and is
generally bullish. Credit spreads narrow as the credit cycle improves. Credit spreads widen as

the credit cycle deteriorates.
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2. Economic conditions -Credit spreads narrow as the economy strengthens and investors expect
firms’ credit metrics to improve. Conversely, credit spreads widen as the economy weakens.

3. Financial market performance -Credit spreads narrow in strong-performing markets overall,
including the equity market. Credit spreads widen in weak-performing markets. In steady-

performing markets with low volatility of returns, credit spreads also tend to narrow as
investors reach for yield.
4. Broker-dealer capital -Because most bonds trade over the counter, investors need broker-

dealers to provide market-making capital for bond markets to function. Yield spreads are
narrower when broker-dealers provide sufficient capital but can widen when market-making

capital becomes scarce.
5. General market demand and supply. Credit spreads narrow in times of high demand for
bonds. Credit spreads widen in times of low demand for bonds. Excess supply conditions, such

as large issuance in a short period of time, can lead to widening spreads.