Question asks:
Determine the expected effect (negative, no effect, or positive) on Intrepid’s performance from each of the following trades, assuming Blanc’s forecasts are realized.
Blanc forecasts a stronger economy and an upward parallel shift in the yield curve.
trade i: Buy a 10-year Ba1/BB+ consumer cyclical sector bond and sell a 10-year Baa3/BBB - consumer cyclical sector bond of another issuer
Answer: Positive.
Reason: This is a classic crossover trade where managers seek bonds of the highest speculative grade rating that are likely to benefit from an upgrade as the economy strengthens. The potential impact of an upgrade is more significant for lower quality bonds.
Intrepid should benefit from a potential credit upgrade and increased liquidity of the 10 -year Ba1/BB+ consumer cyclical bond.
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So I agree with the above but the trade involves shorting a 10-year Baa3/BBB bond which is even lower rated - shouldn’t the positive impact on this bond be even greater since it is even lower quality? If this is true shouldn’t the answer be “negative” since you are short the lower quality bond which will increase in value more than long position in the higher quality bond?
Thanks
Determine the expected effect (negative, no effect, or positive) on Intrepid’s performance from each of the following trades, assuming Blanc’s forecasts are realized.
Blanc forecasts a stronger economy and an upward parallel shift in the yield curve.
trade i: Buy a 10-year Ba1/BB+ consumer cyclical sector bond and sell a 10-year Baa3/BBB - consumer cyclical sector bond of another issuer
Answer: Positive.
Reason: This is a classic crossover trade where managers seek bonds of the highest speculative grade rating that are likely to benefit from an upgrade as the economy strengthens. The potential impact of an upgrade is more significant for lower quality bonds.
Intrepid should benefit from a potential credit upgrade and increased liquidity of the 10 -year Ba1/BB+ consumer cyclical bond.
****
So I agree with the above but the trade involves shorting a 10-year Baa3/BBB bond which is even lower rated - shouldn’t the positive impact on this bond be even greater since it is even lower quality? If this is true shouldn’t the answer be “negative” since you are short the lower quality bond which will increase in value more than long position in the higher quality bond?
Thanks