Corporate credits portfolio

In constructing our hypothetical portfolio of corporate credits, we first identify a suitably diversified list of names that meet our rating and spread requirements. 

The price of a corporate bond is a yield spread for conventional bonds or on an OAS basis for callable or other option-embedded bonds. If an OAS calculation is undertaken in a consistent framework, price changes that result in credit events will result in changes in the OAS. Therefore, we can speak in terms of a sensitivity measure for the change in value of a bond or portfolio in terms of changes to a... 

There are two main types of credit risk that a bond portfolio or position is exposed to. They are credit default risk and credit spread risk. Credit default risk is defined as the risk that the issuer will be unable to make timely payments of interest and principal. Typically, investors rely on the ratings agencies—Fitch Ratings, Moody s Investors Service, Inc., and Standard 8c Poor s Corporation—who publish their opinions in the form of ratings. 

Portfolio quality and inherent diversification The portfolio of European ABS represents credit exposure to different consumer and corporate sectors, across multiple countries and multiple asset managers/ servicers. The portfolio on closing had an average rating of Baa2/BBB. 

In this chapter we addressed the question of what proportions corporate and government bonds of different credit quality and maturity segments an investor should hold in a fixed-income portfolio. Maximizing the risk/ return relation according to the Markowitz approach is the core issue here. Optimal portfolio weights were established in ex post simulations. 

The credit rating of a company is a major determinant of the yield that will be payable by that company s bonds. The yield spread of a corporate bond over the risk-free bond yield is known as the default premium. In practice, the default premium is composed of two elements, the compensation element specific to the company and the element related to market risk. This is because, in an environment where the default of one company was completely unrelated to the default of other companies, the return from a portfolio of corporate bonds would equal that of the risk-free bond. The gains from bonds of companies that did not default compensated for the loss from those that did default. The additional part of the default premium, the risk premium, is the compensation for risk exposure that cannot be diversified away in a portfolio, known as systematic or non-diversifiable risk. Observation of the market tells us that in certain circumstances, the default patterns of companies are related for example, in a recession there are more corporate defaults, and this fact is reflected in the risk premium. 

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