Relative value analysis

Asset-Swap Spreads and Relative Value Analysis... 

CDO Investor combines analytic tools with a historical database of publicly available CDO transactions. Investors can analyze their existing investments, as well as perform relative value analysis between different transactions. CDO Investor allows users to model projected cash flows, find current and historical ratings on CDO tranches, review details on underlying collateral, and make internal rate of return (IRR) projections. 

After assessing a bond with the help of credit analysis, the question arises to what extent the market price of this bond corresponds with the investor s judgement. The market price should compensate the investor for all risks connected with holding the bond. This market price (spread) is often referred to as the return differential between the analysed bond and the benchmark. Frequently, government bonds or the swap rate with matching maturities are used as benchmarks. Another standard reference are bonds of other issuers that are active in the same business field. Since one debt instrument is assessed relative to another debt instrument, this analysis is also called relative value analysis, the basic principles of which are described in this section. 

Historically, comparing the yield of the interesting bond with the benchmark yield may be a first step in relative value analysis. This allows one to examine the implications of events in the past on the spread of the bond. Exhibit 29.3 depicts the yield spread of Swissair and the matching Bund (German government bond) in the period from May 1999 to November 2001. 

Relative value analysis can be distorted by the retail bid phenomenon Issuers with high name recognition (such as Deutsche Telekom in Germany) are more heavily demanded by retail investors. This may lead to spread narrowing and thus a price increase of the bond. 

After getting a rating evaluation, a relative value analysis is performed to decide whether bonds are relatively cheap or expensive in comparison with other bonds. This assessment focuses on market technicals and shonld include factors like liquidity and optionalities such as coupon step-nps. 

Once investors have determined which part of the yield curve to invest in or switch into, they must select specific issues. To make an informed choice, they use relative value analysis. 

Relative value analysis focuses on bond issues located in certain sectors, or local parts, of the curve. Because a bond s yield is a function not just of its duration—after all, two issues with near-identical... 

The I-spread is sometimes used to compare a cash bond with its equivalent CDS price, but for straightforward relative value analysis is usually dropped in favor of the asset-swap spread, which we look at later in this section. 

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