What is meant by spread duration and contribution to spread duration?
What will be an ideal response?
Spread duration is the sensitivity of a bond, bond sector, or bond portfolio to a parallel shift in credit spreads. Its interpretation is the same as for duration, e.g., it is the approximate percentage change in the price of a bond for a 100-basis-point change in the credit spread.Given the spread duration for a bond or bond sectors, the contribution to portfolio spread duration can be determined.A measure that is used as an alternative to spread duration for determining the contribution of a bond sector to portfolio spread duration is one introduced by Barclays Research. This measure is referred to as duration times spread, or DTS. More details are supplied below.
The calculation of the spread duration is the same as for the duration to measure the interest-rate sensitivity due to a parallel shift in the Treasury yield curve. The approximate duration formula is
approximate duration =
where
P_ = price of the bond resulting from a decrease in the Treasury yield
P+ = price of the bond resulting from an increase in the Treasury yield
Δy = change in yield used to calculate the new prices (in decimal form) P_ and P+
For spread duration, the corresponding formula is
approximate spread duration =
where P0 is the same as in the approximate duration equation; P_and P+ now represent the bond prices resulting from a decrease or increase in the credit spread with the Treasury yield held constant; and Δs is the change in the credit spread used to calculate the new prices (in decimal form).
As discussed in the text, the two equation generate the same answer. Thus, these two formulas indicate that duration and spread duration are the same.
A measure that is used as an alternative to spread duration for determining the contribution of a bond sector to portfolio spread duration is one introduced by Barclays Research. This measure is referred to as duration times spread, or DTS. There are two elements whose product is used in computing DTS: spread duration and credit spread. For example, suppose that a bond has a spread duration of 4 and a credit spread of 90 basis points. Then
DTS = 4 × 0.009 = 0.036 = 3.6%
The contribution of a bond or bond sector to a portfolio, referred to as contribution to portfolio DTS, is the product of the DTS and the weight of that bond or bond sector in the portfolio. For example, suppose that the bond whose DTS is 3.6% has a 3% weight in aportfolio, then its contribution to portfolio DTS is:
Contribution to portfolio DTS = 0.03 × 0.036 = 0.00108 = 10.8 bps
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