Workout Period (Trading) - Explained
What is a Workout Period?
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Table of ContentsWhat is a Workout Period?How Does a Workout Period Work?
What is a Workout Period?
Workout period is the time period when adjustments are made for temporary yield differences in fixed income securities. This period works as a reset period where credit rating agencies and institutions issuing bonds analyze problems associated with outstanding fixed income and make adjustments to any differences in price or yield. The purpose of making these adjustments is to make the market more efficient.
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How Does a Workout Period Work?
In some cases, there can be a mismatch in the yield received from same type of bonds in the fixed income market. For example, there can be a significant difference in the yield for two similar bonds having exactly same coupon, and maturing on the same date. Analysts seek to rectify these mispricing issues during the workout period. The tenure of this period can vary a lot. Sometimes, it could be set for a short period of time, and sometimes, it lasts until the bond matures. With ongoing trading during the workout period, the bond value significantly declines, and the anticipated recovery yield reduces the price. For having the ultimate benefit from the workout period, investors usually invest in a bond or sector swap. For instance, in case an investor stipulates that the yield spread between two bonds is very broad, he or she will try to achieve the objective of capitalization of price/yield fluctuations by making changes in his or her investment from the bond that offers higher yields to the one that offers lower yields. If the investors estimate for the workout period is right, he or she will gain steadily from the adjustments made in yield. If the differences in yield are more and the workout period is small, the investor would receive more returns from the bond swap. One can observe the workout period in the lending industry as well. In case of default in repaying loans, the lender extends the tenure of the loan so as to provide more time to the borrower to pay his or her debt. And, the borrower tries to repay as much as possible during this recovery phase. In case, the borrower cannot make more payments, the default is considered to be settled, and this marks the end of the recovery process. Here, workout period is the time period that starts from the default date, and ends on the date when the issue is resolved..