Long/short CDX clarification

CFA Level II Fixed Income
#1

Hi everyone, could you please help me clarify this exercise?

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Now here is my thinking: the curve will steepen, so with a normal bond strategy we would be long short durations and short longer durations. CDX are essentially giving an opposite exposure (buying a CDX is like being short bonds) so I just thought I would reverse my logic and therefore be: short, short duration and long longer durations (answer C). Can you help me clarify here?

If the economy gets better, then spreads will tighten, hence better to sell a CDX now at higher premiums before their value decrease.

#2

Anyone?

#3

If the spread tightens, that means credit quality has improved. If you brought protection (short), you would have lost money because your protection wasn’t warrantied. If you sold protection (long) you would have made money.

#4

Exactly, what my suggestion is: take advantage of the tightening spreads on short durations by selling protections. But that would have been wrong according to the books’ answer (i.e. short a 20-year CDX and go long a 2-year CDX.)

#5

No, I just repeated your reasoning… If the spread is tightening, thats what would happen (not a curve trade)

However, he problem describes the steepning as a short term view (not long term)…

#6

I also found very confusing the information on these 2 or 3 last EOC exercises. I found this topic that helped me understand the long/short vs buy/sell protection: https://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91327802 I do now understand the point.