It’s from finquiz.
An investor holding intermediate term bonds issued by a company anticipates a general downward shift in its credit curve reducing all rates by an equal 150 basis points. In order to exploit his views in a cost effective manner which generates the lowest level of risk, the investor will most likely undertake a:
the answer is: a short position in a long-term CDS and a long position in a short-term CDS.
The reasoning is:
In general long-term CDS are more sensitive are more sensitive to changes in rates relative to short-term CDS. Since the investor believes rates will go down, he will want to be long CDS. Given that the long-term CDS will move more than the short-term CDS, he will take a long position in the long-term CDS and balance this position with a short position in short-term CDS. The premium earned by the short position will reduce the premium paid on the long position. Furthermore, volatility of the position will be reduced if the investor balances the sizes of the two positions.
My thought process is:
When interest rates are expected to shift downward, risk is going down. In which case your CDS is worth less. In the answer, if the long term CDS is more interest rate sensitive, wouldn’t you stand to lose the most going long that as opposed to the short term CDS?