Monday, September 26, 2011

Yield as relative value comparator

Yield is the most versatile, convenient (therefore most popular and practical) soft market data for relative value comparison. Yield lets you

- compare across currencies
- compare across time horizons (yield curve)
- compare across credit qualities (credit spread)
- compare across disparate coupon frequencies including zero-coupons
- compare across disparate call provisions
- compare government vs private issuers
- compare across vastly different industries
- compare across big (listed) vs small companies and even individual borrowers
- compare across eras like 70's vs 90's
- compare with interest rates. In fact, lenders use credit spread and prevailing IR to derive a lending rate on each loan.

Why is yield such a good comparator? Yield is a soft-market-data item derived using many inputs. Yield, in one number, captures the combined effect (on what? Of course valuation) of many factors such as

* different credit qualities
* different probabilities of default
* different embedded options
* different coupon rates
* comparable (but different) maturities

Without capturing all of these differences, it's unwise to even attempt to compare 2 bonds. You get an obviously biased comparison; or you get an incomplete comparison. No info is better than misleading info.

Yield is so widely adopted that major data sources directly output yield numbers, making yield a "raw" market datum rather than a "soft" market datum.

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New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin