Q4 asks which sector would be best for a short position given the economic forecast of lower GDP.
i chose the answer with the tightest spread (option 3) - Answer is Option 2 - a BB rated discretionary staple firm. Why is this the case? My thinking was that if the GDP is forecasted to fall we want to protect by going for tighter spreads as opposed to more risky? Or is this something to do with the fact we are shorting?
Bond 1 is in a non-cyclical industry, unlike Bond 2, which is in a cyclical industry. Bond 1 has a slightly higher debt-to-capital ratio than Bond 2 but not material. Bond 2 has a relatively tight spread compared with Bond 1. These factors suggest that Bond 2 is a better candidate for a short position. During an environment in which GDP is forecast to surprise to the downside, higher-rated issues, such as Bond 3, are likely to outperform. Given Quantum’s expectation for declining GDP and its relatively tight spread, Bond 2 is the best candidate for a short position.