# Ss10 - fixed income ii - Eoc qn#4 - Credit Forwards

[question removed by admin] I somehow thought pay off to a forward instrument = spot - forward contract price; but the given solution does not agree!

Payoff of Credit Spread forward = (Forward Spread at expiration - Strike Spread) * Notional * Risk Factor

= (0.025 - 0.03) * 10 Million * 5 = -0.25 Mill = -250,000 \$

this is a loss to the Money money funds.

is this correct?

If she expects a narrowing in spread, she should be shorting the credit spread forward, not long. Hence the payoff should be (Strike - Forward Spread)*Notional*Risk Factor which equates = \$250,000

In my opinion, she should have used a binary credit option, using a put option to benefit from the narrowing of spread. Open for discussion

Sorry CPK,

“The payoff to More Money Funds would be: Payoff = (0.030 − Credit spread at maturity) × \$10 million × 5 A Payoff = (0.030 − 0.025) × \$10 million × 5 = \$250,000.”

now, what is “taking a forward position that credit spread will decrease” mean?

chngstr, I don’t know what “shorting a forward” means.i thought you enter into a forward at a contract price. Your pay off is purely determined by the spot.

I’m confused. I need some1 like cp/Jana to see what’s going on

if credit spread is expected to decrease - and you want to benefit from the decrease in the spread - you would short the credit spread forward.

if the spread is expected to increase - to profit from the forward - you would go long on the credit spread forward.

that is what Chngster is indicating.

(and thanks that is something I had missed before).

Thanks both CPI and chngstr