FI Structural trade

[derswap07]

” Structural analysis of corporate bonds is an important part of active management. Credit bullets in conjunction with long-end Treasury structures are used in a barbell strategy. Callable bonds provide a spread premium that can be valuable to an investor during periods of high interest rate volatility. Put structures will provide investors with some protection in the event that interest rates rise sharply but not if the issuer has an unexpected credit event.”
This statement is most likely correct with regard to which structural trade?
A. Putables
B. Bullets
C. Callables

 

[magicskyfairy]

Both A and B seem correct to me. C is 100% wrong cuz higher volatility will mean the option is more likely to pay out (and since you sold the option, you, then, are more likely to pay out and lose money).
B is correct because that’s a “credit barbell”, as described in reading 22, except it was described with 1year junk bonds on the short end, and 5-10 year treasuries on the long end - but that’s close enough.
A seems correct to me as well because if interest rates shoot up, you can use the put option to force the issuer to pay you back the par value (or whatever the agreed value of the put was). However, if that issuer has a credit event, presumably, they are in some trouble - so while their bond may lower in value, it is probably not possible to use the put option because that would likely just cause a default, and you wouldn’t get your money.
All this said, the official answer from CFAI is B, bullets, but I don’t understand why putables is not a correct answer, so if someone else does, please tell me.

 

[Hard Dollars]

magicskyfairy wrote:
All this said, the official answer from CFAI is B, bullets, but I don’t understand why putables is not a correct answer, so if someone else does, please tell me.

“Assuming that the issuer still has the capability to meet its sudden obligation, put structures triggered by a credit event enable investors to escape from a deteriorating credit. “
Source: Curriculum (Reading 22: section 8 Part D)

 

[magicskyfairy]

^ha, so in other words, the issuer’s ability to honor the put is the contingency, but you might actually be able to recover the money. I understand the answer now, but I do find this question is a bit dirty.
Thanks for the post, hard dollars