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Yield and Credit Spread Considerations for Illiquid Corporate Bonds

Article Quant Q&A · Author: Zedi10
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Summary

The document raises valuation questions for a privately issued, illiquid Indian corporate bond with an amortizing principal schedule and a high coupon. It asks which components belong in a discount yield, how to update valuation over time, how to estimate a credit spread when comparable rated bonds are unavailable, and how to explain the coupon. The response distinguishes yield calculation from risk-free-rate analysis: yield follows from the bond’s price and cash-flow terms, including maturity, coupon, payment frequency, and day-count convention.

For spread measurement, the response describes a Z-spread approach: shift the risk-free spot curve until discounted cash flows match the observed bond price. It interprets a high coupon or yield as compensation for elevated issuer default risk. The answer is brief and does not provide a method for estimating an appropriate spread for an illiquid issuer without comparables, nor does it explain ongoing valuation adjustments or the complications of amortizing cash flows. These remain important limitations for applying the guidance to the case described.

Key ideas

  • Bond yield can be computed from price and contractual cash-flow terms without first identifying the risk-free rate.
  • A Z-spread is found by shifting the spot curve until modeled value matches market price.
  • A high coupon or yield can reflect compensation for greater credit risk.
  • The response does not solve the challenge of estimating credit spread without comparable bonds.

Tags

Fixed incomeDerivatives pricingRisk management
Full text
# Yield for valuation of illiquid corporate bond


# Yield for valuation of illiquid corporate bond












I am trying to value a illiquid corporate bond issued at a discount to face value by a privately held company in India. The corporate bond is a sinkable bond (amortizing principle) with coupon rate of more than twice the risk free rate of the country.

Questions:

- What all should be component of discount yield of the bond

- Once we have identified the components on the issuance date, how do we carry on the valuation as on different dates

- How do we identify the credit spread for the bond issued (since this is a privately held company in a sector where bonds with similar ratings are unavailable

- How can one justify such high coupon for the bond

## Answer by Jordan Lisiewicz (score 1)

https://quant.stackexchange.com/a/33698

- The yield of the bond depends on the discount to par at which it was issued, its maturity date, coupon rate, payment frequency, and daycount conventions. Yield computations do not require you to know the risk-free rate.

- You can compute yield using the YIELD function in excel with the correct inputs.

- What kind of spread are you referring to, ZSpread? This would require you to shock the risk-free spot curve until you price the bond to its current market price.

- High coupons are justified by high credit risk of the issuer. A high coupon/yield generally means that the issuer has a high risk of default. Investors must be compensated for this risk with a higher return on their investment.

You can find more details on yield interpretation and computation and this pretty good guide: https://quantcoyote.com/2017/03/14/bond-yield-explained/

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.