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??
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