Which of the following statements best describes a credit curve roll-down strategy?
A Returns from a credit curve roll-down strategy can be estimated by combining the incremental coupon from a longer maturity corporate bond with price appreciation due to the passage of time.
B A synthetic credit curve roll-down strategy involves purchasing protection using a single-name
CDS contract for a longer maturity.
C A credit curve roll-down strategy is expected to generate a positive return if the credit spread curve is upward sloping.
C is correct. A credit curve roll-down strategy will generate positive return only
under an upward-sloping credit spread curve. As for A, the benchmark yield
changes must be separated from changes due to credit spreads, and under B, a synthetic credit roll-down strategy involves selling protection using a single-name CDS contract for a longer maturity.
Erm… still, why is A not correct, anyone? Thank you!
Struggling on this as well and found it as one of my ‘questions to revisit’ in my notes. Here’s my thoughts but would love someone else to clarify.
So the answer is saying that benchmark yield must be separated from credit spreads. A) is saying we can take (long maturity corporate coupon - shorter maturity corporate coupon) and use the passage of time and subsequent price change as a way to approximate credit curve roll return. This doesn’t work, since the difference in corporate coupons reflects all aspects of bond risk, and not just the parsed out credit risk. If we had (somehow) a HY bond and an IG bond of identical economics (besides credit exposure, I guess we could use that to approximate credit roll down?
This is because A. refers to coupons in absolute terms. In reality, bond values will shift based on how rates/benchmark bonds will shift. So the absolute level of the coupon is not very relevant, to the first order.
If they had mentioned spread instead of coupon, then it would have been true.
Which ofc is what C. is about.
