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Question of the Week: Level 3 - Fixed Income

Which option below to hedge pension liabilities has the least amount of spread risk?

Question of the Week: Level 3 - Fixed Income 6 votes

A. Received-fixed swaps.
50% 3 votes
B. Assets of higher quality than the liabilities.
16% 1 vote
C. Futures contracts on the 10-yr US Treasury notes.
33% 2 votes

Comments

  • MarkMeldrumMarkMeldrum OntarioPosts: 52 Associate
    The correct answer is Option A. 

    Both Option B and Option C result in Asset BPV derived from government bonds.  Movements in the corporate – Treasury yield spread introduce risk to the hedging strategy. Usually, yields on high-quality corporate bonds are less volatile than on more-liquid Treasuries.

    For Option A, the spread risk is between high-quality corporate bond yields (the pension liabilities) and swap rates. Typically, there is less volatility in the corporate/swap spread than in the corporate/Treasury spread because both Libor and corporate bond yields contain credit risk vis-à-vis Treasuries.

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