An investor holds fixed income securities in his portfolio, not to maximize investment return, but to dampen its overall volatility. But by shortening maturities of these holdings around interest rate troughs and lengthening maturities around interest rate peaks, he can achieve a small return increment.

The investor can also improve the performance of his portfolio by identifying yield spreads that are out of line with historical spreads obtaining in comparable market conditions. Even trading based on yield spreads, however, requires an ability to discern the general direction of interest rate movements.

The author demonstrates this by regressing four representative spreads — issuer, quality, coupon and arbitrage — against the level of AA utility yields. His results suggest that the general level of interest rates explains a significant part of the observed variation in issuer, quality and coupon spreads, although somewhat less of the variation in the arbitrage spread. Thus bond trading based on spreads will not be consistently successful unless the future level of interest rates is taken into account.