credit curve steepener cheaper, default, investor, correct, different

torontoanalyst

A) buys a short-term credit default swap and sells a long-term credit default swap.

B) sells a credit default swap on a firm’s subordinated debt and buys a cheaper credit default swap on the senior debt.

C) buys a long-term credit default swap and sells a short-term credit default swap.


Your answer: A was incorrect. The correct answer was C) buys a long-term credit default swap and sells a short-term credit default swap.

In a curve trade, an investor has different opinions about the long term versus short term prospects for a bond issuer. The trade can be a flattener or a steepener. In a credit curve steepener, the investor believes that the issuer has the ability to subsist in the short term, but that its long-term prospects are poor. The sale of the short-term credit default swap partially finances the purchase of the long-term credit default swap.


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I would think that if you buy a short term cds than the short side of the curve would tighten and steepen the curve. What am i misunderstanding??

Thanks

zhaoyp

Check out LOS 63.d. "Discuss credit derivatives trading strategies and how they are used by hedge funds and other managers".

The LOS covers these strategies:
* Basis Trades,
* Curve Trades,
* Index Trades,
* Options Trades,
* Capital Structure Trades and
* Correlation Trades.

The Curve trades strategy consists of a flattener or steepener strategy.

genuinecfa

book 6 cfai page 359 curve trades

jarobi04

what the reading for this?

mengxu

buy a long-term CDS, and short a short-term CDS, aint rocket science, now first-to-default correlation baskets, that's some sweet stuff

maryli

think of steep being the risk is getting worse for the "entity" with the risk steeping upward, we sell short and buy long

with a flattner, the risk is better in the long run, buy short, sell long

thats what helps me remember

Otabek

Sorry about that -- here is the question

Which of the following most accurately describes a credit curve steepener trade using credit default swaps? The investor:

A) buys a short-term credit default swap and sells a long-term credit default swap.

B) sells a credit default swap on a firm’s subordinated debt and buys a cheaper credit default swap on the senior debt.

C) buys a long-term credit default swap and sells a short-term credit default swap.


Your answer: A was incorrect. The correct answer was C) buys a long-term credit default swap and sells a short-term credit default swap.

In a curve trade, an investor has different opinions about the long term versus short term prospects for a bond issuer. The trade can be a flattener or a steepener. In a credit curve steepener, the investor believes that the issuer has the ability to subsist in the short term, but that its long-term prospects are poor. The sale of the short-term credit default swap partially finances the purchase of the long-term credit default swap.

FinancialAnaly

this might be out of the scope of the test. I have studied the material front and back an never heard of these terms. that being said the answer does make sense. If your opinion it that Greece will be able to meet its short term debt obligations but not in the long run. You will sell short term CDS, take that premium and buy long term CDS.

Newhuman

You didn't even post the question. I don't even know what "subsist" mean and I've never heard of a "credit curve steepner". I'd stick with CFAI EOCs with time remains, much more accurate.