An investor believes that a bond may temporarily increase in credit risk. Which of the following...

Question:

An investor believes that a bond may temporarily increase in credit risk. Which of the following would be the most liquid method of exploiting this?

a. The purchase of a credit default swap

b. The sale of a credit default swap.

c. The short sale of the bond.

Credit Risk:

The credit risk is the risk that the debt security would not be able to pay its due payments. This leads to the default and just one default period may lead to bankruptcy.

Answer and Explanation:

An investor believes that a bond may temporarily increase in credit risk. Which of the following would be the most liquid method of exploiting this?

a. The purchase of a credit default swap.

The credit default swaps would provide positive payoff when a credit event happens. Therefore, it would be helpful in the current situation.


Let's analyze the incorrect options:

b. The sale of a credit default swap. - The sale would provide a negative payout.

c. The short sale of the bond. - This would also provide a positive payoff but the liquidity would be low.


Learn more about this topic:

Loading...
Financial Risk: Types, Examples & Management Methods

from Finance 305: Risk Management

Chapter 1 / Lesson 4
26K

Related to this Question

Explore our homework questions and answers library