-89-
The observable quality spread in the bond markets makes it
possible to calculate an appropriate adjustment for credit
quality. Assume, for example, that a U.S. Treasury bond priced
at $101.25 would have an estimated fair market value of $99.83
if, instead, it was a like bond issued by an AAA-rated
corporation. The $1.42 difference between the two bonds is the
credit adjustment for an AAA-rated bond issuer. If the same bond
would have had an estimated fair market value of $98.91 if it had
been a like bond issued by an A-rated corporation, the $2.34
difference between the price of the Treasury and A-rated bonds is
the credit adjustment for an A-rated bond issuer. The 92-cent
difference between the estimated fair market values of the
AAA-rated bond and the A-rated bond is the incremental credit
adjustment as of the date of valuation.31
D. Other Adjustments
1. Investing and Funding Costs
The G-30 report recommended an adjustment for investing and
funding costs for portfolios that are not “perfectly matched”.
This adjustment, the G-30 report stated, relates to “the costs of
funding and investing cashflow mismatches at rates different from
the LIBOR rate which models typically assume”. This adjustment
is also mentioned in BC-277.
31 The market price of credit risk fluctuates over time.
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