comp_sci_kid

Wayne1106 Wrote:
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> I am going over the alternative investment section
> in schweser and I came across a sentence where it
> seems to be a bit odd to me. I was wondering if
> someone might be able to help me out with this.
> Book 4 Page 102 it says "A fund might go long a
> corporate bond and short a Treasury bond, thereby
> earning the difference in yields. However, these
> funds can suffer large losses if the yield on the
> risky bond rises while the yield on the Treasury
> falls."
>
> I might just be a little confused but I don't see
> why the second sentence corresponds with the
> first.

Let's say both corporate bond and treasury have face value of $100 and zero coupon. You buy corporate bond at $60 and sell treasuries at $90 hoping that you will earn the yield spread. However, if the treasuries yields fall (e.g. treasuries go up to $95 just due to that, not time) and corporate yields go up (e.g. corporate bond goes down to $40), you will be losing $5+$20 = $25. does that help?