Duration Weighted Spread ??

[Taurean]

Hi David,

It took me long time to come to this level before I felt the need to ask an expert!

We have a spreadsheet where bigwigs from our company calculate Duration Weighted Spreads for asset-backed securities issued in the bond market. As we are not the end user of the spreadsheet, we never meddled with it and just updated certain sections of the spreadsheet and passed it over to the senior folks, who belong to some other group and due to compliance reason never clarified such doubts with them.

However, I've always been curious to know why this Duration calculation is not the same as we know it in the industry parlance - Bond price sensitivity to interest rate movements, measured in years.

Here is how they calculated it. Assuming I were to put these in the spreadsheet.

Cell A1: name, "Classes", Cell B1: "Amount", Cell C1: "Weighted Average Life of Bond", Cell D1: "Bond Priced at" (like 1ML + 10, SWAPS + 75 etc.), Cell E1: "Spread", Just the spread over the benchmark rate (like 10 and 75, from cell D1.

Cell A2, A3, A4, A5 and A6 have Class A, B, C, D and E
Cell B2, B3, B4, B5 and B6 have size of the bond class: $20,000,000 ; $250,000,000 ; $375,000,000 ; $45,000,000 ; and $30,000,000 , respectively.
Cell C2, C3, C4, C5 and C6 have WAL of 0.21, 1.12, 1.90, 2.69, 3.65 (all in years)
Cell D2, D3, D4, D5 and D6 have 1ML + 10, EDSF + 27, EDSF + 49, SWAPS + 98, SWAPS + 129
Cell E2, E3, E4, E5 and E6, have just the spreads 10, 27, 49, 98, 129

Now Cell F1 is "Duration Weighted Spread", and Cell F2 contains the formula SUMPRODUCT($B$2:B2*$C$2:C2*$E$2:E2)/SUMPRODUCT($B$2:B2*$C$2:C2) which is subsequently copied to Cell F3, F4, F5 and F6 and we get 10, 27, 43, 49 and 56 - my question is what does these spreads tell you?

Thanks, Taurean

 

[ShaktiRathore]

Hi,
Portfolio of only A class will have spread of 10 portfolio of A and B will have duration adjusted spread of 27 the higher weight of B along with the higher duration will tilt the overall spread of portfolio towards the spread of B and since the B has higher duration the overall portfolio duration is on higher side. Similarly now going to Portfolio of A, Band C the higher weight of C along with the higher duration will tilt the overall spread of portfolio towards the spread of C. Now since now we attach lower weights to D and E the overall duration of portfolio will not get affected much due to which the spread of the overall portfolio will not rise much.
Higher weights are attached to B and C in portfolio of A,B,C,D,E so that overall duration approximates of portfolio to that of B and C and thus the entire spread of the portfolio resembles the B and C combination.So the last column speaks of the portfolio adjusted spread after taking into account sequentially the above bond classes this is what i can infer.
Additional note:The spreads are reflection of the duration of the bond classes. That is we weight the spread as reflection of the duration that is higher duration(which implies higher WAL) means higher spread for the bond class. Bond A with duration .21 has least spread which is 10.Now as can be seen as the duration of bond classes keeps on increasing the spread keeps adjusting to higher levels, so that B,C,D with increasing duration have increasing spreads. I mean the last column of duration adjusted spread speaks this only that the spread are increasing with increase in the bond's duration besides the portfolio conclusion.

thanks

 

[aadityafrm]

Duration-weighted spread (DWS) provides an estimation of a portfolio’s credit risk. The DWS represents the maximum possible gain if credit spreads drops to 0, or conversely the maximum loss should the spread doubles. the DWS of a security is a product of weight in amount, Duration (in this case, WAL of asset backed securities) and its spread. If we take a portfolio, the Spread weighted by the overall portfolio duration i.e sumproduct (weights in amount of all securities* corresponding WAL) corresponds to the sum total of individual contributions. i.e
DWS of portfolio * Sumproduct(weight of security i* WAL for security i) = Sumproduct (weight of security i* WAL for security i*spread of security i). Hope this interpretation helps.