Devivative - downgrade

CFA Level III Derivatives
#1

If the bond is expected to downgrade , which credit derivative is best to mitigate ? Why

  1. credit spread option

  2. credit forward

  3. binary credit option

the ans is 3) but I don’t know why , please help

#2

If I understand correctly, binary credit options are event specific, the spreads do not have to change. So all else equal, it’s the best choice for a downgrade.

#3

Thanks for your replying MrSmart. You mean that the downgrade doesn’t imply the spread will be widen so option 1) & 2) is not the best ans ?

#4

Exactly, credit spreads narrow and widen way before credit agencies proceed to change their ratings.

#5

Understood thanks again MrSmart