An active credit portfolio manager considers the following corporate bond portfolio choices familiar from an earlier example:

The investor anticipates an economic slowdown in the next year that will have a greater adverse impact on lower-rated issuers. Assume that an index portfolio is equally allocated across all four rating categories, while the investor chooses a tactical portfolio combining equal long positions in the investment-grade (A and Baa) bonds and short positions in the high-yield (Ba and B) bonds.

Calculate excess spread under an economic downturn scenario for the index and tactical portfolios where both OAS and expected loss rise 50% for investment grade bonds and double for high-yield bonds.

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Rating Category A Baa Ba B Current OAS 1.05% 1.35% 2.45% 3.50% Expected Loss (POD X LGD) 0.06% 0.30% 0.60% 3.00% EffSpread Dur 5.5 6.0 4.5 4.0