Apply your background knowledge to credit issues
While our mental maps are useful in helping us apply what we already know, they are not so helpful when it comes to learning something new.We may think we know something based on an experience and transfer that knowledge to a new experience—only to discover that our mental map is outdated and no longer useful. In a new partnership, we have to be careful how we transfer information based on past history. This is especially challenging, though, since knowledge transference is a common reasoning technique.
Here’s the magic of mental maps. A client of mine, the owner of a grocery store chain in the Midwest, wanted to form a partnership with several contractors to rebuild a grocery store in a chic section of town.He needed to keep the store open during the rebuilding process. Much work was done to bring the store managers and contractors together to talk about the customers’ shopping experience during the remodeling. They wanted to figure out how they could partner not only to complete the extensive construction job, but also to keep people coming in during the remodeling. The reconstruction went off without a hitch. Although shopping was more of a challenge during that period, people continued to shop there—and, remarkably, sales dropped only a few percentage points. Considering the amount of work, this was an incredible feat.
One typical reason for spread differentials between bonds of the same rating are liquidity considerations, particularly with respect to stress situations. enerally, bonds with a large issue size, issued recently and actively traded by several market makers tend to be the most liquid. Sometimes old bonds with a small issue size, too, trade at rather tight levels. This is often the case for typical “CDO (Collateralized debt obligations) names”, that is bonds that are often included when CDOs are set up. Another reason for wide spread differentials between issuers with similar credit quality is that many market participants are concerned with potential mark-to-market losses. Therefore, rather illiquid and more volatile bonds require a higher spread, even if spread volatility is rather due to market technicals than uncertainty regarding company fundamentals. Consequently, it is natural that credit spreads differ even for bonds and issuers with the same rating.