DEFINITION of Workout Period
Workout period is the period of time when temporary yield discrepancies between fixed income securities are adjusted. A workout period can be viewed as a sort of reset period, in which bond issuers and credit rating agencies review outstanding fixed income issues and adjust any discrepancies in price/yield, in order to correct any inefficiencies in the market.
BREAKING DOWN Workout Period
Sometimes, the yield relationship among similar bonds is misaligned in the fixed income market. For instance, the yield on two identical bonds with similar coupon and maturity may vary considerably. This mispricing is expected to be corrected during a period known as the workout period. The workout period could be a short time frame or it could be a period equal to the entire duration of the bond’s life, which is the worst case scenario.
During the workout period, the value of a bond held in a portfolio drops as trading continues, and the price is discounted by the expected recovery yield. Investors typically take advantage of the workout period by participating in a bond or sector swap. For example, if an investor believes that the yield spread between two bonds is too wide, his investment would be moved from the higher yielding bond to the lower yielding bond in an attempt to capitalize on the price or yield discrepancy. If the investor has guessed the expected workout period correctly, the investor will have a quick gain from the yield adjustment. Generally, the larger the yield differentials and the shorter the workout period, the greater the return from the bond swap.
The workout period can also be observed in the lending sector. When a loan is defaulted on, the term of the loan will be extended by the lender to allow more time for the lender to recover its debt. During this recovery process, the borrower makes as much repayment as s/he possibly can on the loan. When no more payments can be paid by the borrower or obtained by the lender, the default is deemed to be resolved and the recovery process ends. The period from the default date to the resolved date is the workout period.