(a) Consider the following quote from Reuters:The poor correlation between CDS and cash in Swedish utility Attentat (VTT.XE) is an anomaly and investors can benefit by setting up negative basis trades, says ING. 5-yr CDS for instance has tightened by approx. 5 bp since mid-May while the Attentat 2010 is actually approx. 1 bp wider over the same period.Buy the 2010 bond and CDS protection at approx midas +27 bp. (MO)
i. Display this position on a graph with cash flows exactly marked.
ii. Explain the logic of this position.
iii. Explain the numbers involved. In particular, suppose you have 100 to invest in such a position, what would be the costs and expected returns?
iv. What other parameters may have caused such a discrepancy?
(b) Explain the logic behind the two following strategies using cash flow diagrams.Sell DG Hyp 4.25% 2008s at 6.5 bp under swaps and buy Landesbank Baden-Wuerttemberg 3.5% 2009s at swaps-4.2 bp, HVB says.The LBBW deal is grandfathered and will continue to enjoy state guarantees; HVB expects spreads to tighten further in the near future.Also, WestLB mortgage Pfandbriefe trade too tight. Sell the WestLB 3% 2009s at 5.4 bp under swaps and buy the zero risk weighted Land Berlin 2.75% 2010s at 2.7bp under. (TMA)
(c) The following quote deals with implied forward rates in the credit sector. Using proper diagrams explain what the trade is.Implied forward CDS levels look high because shorter-dated CDS are currently too cheap to 5-year, says BNP Paribas. Using the iTraxx Main curveas reference gives a theoretical 3-year forward curve that shows 6-month and 1-year CDS both at 60 bp.“In 3-years time, we find that 6-month and 1-year CDS are very unlikely to be trading above 60 bp.”Take advantage through the 3-5-10-year barbell, buying iTraxx 3-year at 20.75 bp for EUR20M, selling iTraxx 5-year at 38 bp for EUR25M, and buying iTraxx 10-year at 61.25 bp for EUR7M.The trade has a yearly carry of EUR32,000 for a short nominal exposure of EUR2M.