credit strategy

问题如下：

Jean Fitzpatrick is a senior director where he specializes in the corporate and sovereign bond markets. Yield spreads have recently narrowed for corporate and sovereign bonds, but Fitzpatrick still believes the economic recovery will continue and limit any material widening from current levels.

Fitzpatrick observes that bond and CDS spreads in the energy sector are relatively wide compared to other investment-grade sectors. Fitzpatrick informs Charlie Fontaine, head of trading, that he will allocate $5 million to the energy sector and plans to exit the trade in one year.

Fontaine provides Fitzpatrick with market levels on CDS contracts in Exhibit 1 for Regal Energy, an investment grade company in the energy sector that is domiciled in Brazil. Fontaine suggests that Fitzpatrick pursue a rolldown strategy using either 5-year or 10- year CDS contracts and assumes spreads remain constant over the next year. Fontaine notes that the 9-year CDS has an effective spread duration of 8.0 but that its spread is not currently quoted. All Regal Energy CDS have a 1.0% coupon

A. Describe the rolldown strategy most likely to generate the highest excess returns given the spreads provided in Exhibit 1. Calculate the total notional return of the rolldown strategy over one year.

选项：

解释：

Correct Answer:

Selling ten-year CDS protection is most likely to generate the highest excess returns based on the market levels in Exhibit 1 and the assumption that spreads remain constant.

Selling protection will provide long exposure to the credit, and he is most likely to select the ten-year contract because it provides for additional price appreciation compared to the five-year contract.

The total notional return would be approximately $134,932.

The total return on the strategy will be the sum of the coupon income and price appreciation over the one-year holding period multiplied by the notional position.

Start by calculating the CDS ten-year price at purchase:

CDS Price ≈ 1 + (Fixed coupon - CDS spread) × EffSpreadDurCDS

CDS 10-year Price = 0.9125 = 1 + (1% - 2.00%) × 8.75

Next, calculate the CDS nine-year price. To find the nine-year spread (assuming spreads remain constant over the one-year period) interpolate using the weighted average of five-year and ten-year spreads:

5-year CDS weight = 20% = (10 - 9) / (10 - 5)

10-year CDS weight = 80% = (1 – 5-year weight)

CDS 9-year spread = weight of 5 × CDS 5-year spread + weight of 10 × CDS 10-year spread

CDS 9-year spread = 1.90% = 20% × 1.50% + 80% × 2.00%

CDS 9-year price = 0.928 = 1 + (1% – 1.90%) × 8.0

Price appreciation = (CDS 9-year price – CDS 10-year price) / CDS 10-year price

Price appreciation = 1.6986% = (0.928 – 0.9125) / 0.9125

Coupon income = 1.00% (1.0% investment grade coupon for the year)

Total return = 2.6986% = 1.0% + 1.6986%

Total notional return = $134,930 = 2. 6986% × $5,000,000