P
Pulit Chhajer
Member
Could you please help me to distill down the thought process w.r.t below theory as pulled from Acted Material
Yield differences and position relative to a yield curve
In considering possible anomaly switches, yield differences are widely used to identify
individual bonds which seem cheap or dear in relation to other bonds. However, because
high-coupon bonds are likely to have higher gross yields than low coupons, a high gross
yield does not in itself indicate that a bond is cheap.
A problem with the evaluation of individual bonds in relation to a fitted yield curve has been
the stability of the method used to fit the curve.
In other words, small changes in yields on a few stocks can sometimes cause large changes in the
fitted curve. An unstable fitted curve is a poor benchmark to compare individual stocks against.
Price ratios
These can be monitored as well as yield differences. Ideally, a switch under consideration
will look attractive, in relation to both yield and price histories. A practical problem in using
price ratios is that they do not allow for the fact that the two bonds may have different
coupons; they will have different prices but will both be redeemed at 100. So the ratio of the
two prices will display a trend. This history of price ratios may be adjusted by this trend to
produce what are often known as ‘stabilised’ price ratios.
Yield differences and position relative to a yield curve
In considering possible anomaly switches, yield differences are widely used to identify
individual bonds which seem cheap or dear in relation to other bonds. However, because
high-coupon bonds are likely to have higher gross yields than low coupons, a high gross
yield does not in itself indicate that a bond is cheap.
A problem with the evaluation of individual bonds in relation to a fitted yield curve has been
the stability of the method used to fit the curve.
In other words, small changes in yields on a few stocks can sometimes cause large changes in the
fitted curve. An unstable fitted curve is a poor benchmark to compare individual stocks against.
Price ratios
These can be monitored as well as yield differences. Ideally, a switch under consideration
will look attractive, in relation to both yield and price histories. A practical problem in using
price ratios is that they do not allow for the fact that the two bonds may have different
coupons; they will have different prices but will both be redeemed at 100. So the ratio of the
two prices will display a trend. This history of price ratios may be adjusted by this trend to
produce what are often known as ‘stabilised’ price ratios.