Cash & Loans Advice Blog

When a credit curve is steep

On the other hand, if one has a negative short-term view on a credit but believes it to survive for the next 5 years, its credit quality will improve significantly. This view can be expressed via buying a long-dated 30-year par asset swap and buying 5-year protection on the single name thereby creating a long forward spread position (or buying short-dated default protection and selling longer dated default protection). This position would benefit from a flattening of the credit curve.

A steep credit curve implies a steep forward credit curve. A forward default swap is buying or selling protection for the given maturity at a given point in the future at the forward CDS spread. For example, Munich Re senior 2-year protection is at 21 bp and the 7-year protection trades at 34 bp. Selling 2-year protection and buying 7-year protection results in a 5-year CDS two years forward (2 _ 5 spread) at a level of 40 bp.

How to pick the right credit option

Directional trades: This refers to a situation where the CDS market can be used to take a low-cost bearish view because of a negative basis. If the basis is positive and has widenend for “technical” reasons, it possibly represents an opportunity from a hedging-driven market dislocation. Next post provides an example for Siemens.

Spread trades: Investors who are positive about France Telecom relative to Vodafone can express this outperformance view via selling protection in France Telecom versus buying protection in Vodafone. Depending on the chosen credits this could result in high positive carry trades.

Curve trades/Forward trades: As an issuer’s credit quality deteriorates, the spread curve of the issuer moves from being upward-sloping to inverted. Default curve inversion may present an opportunity to shorten maturity and enhance yield. Curve inversion in the default market also allows investors to purchase forward protection at lower levels. This can be achieved by buying longer dated protection and selling shorter dated protection.

Reducing sales costs and improving credit efficiency

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This information is particularly valuable when in-depth product information is needed, and it can be provided directly to distributors as well as the salesforce.

The internet allows products to be evaluated quickly and easily without assistance, which can be particularly valuable for complex products or rapidly evolving markets. As a result, product and technical experts can be used for greater value-added activities. Furthermore, if the sales system is effective, complex, customised price quotations can be prepared for customers, possibly without sales people intervening. This has various advantages: it provides an immediate response to customers’ enquiries, reduces the lead time for sales, ensures accurate hand-over of order details, and saves time and effort in taking and transmitting orders. In effect, everything is done better, more quickly and more costeffectively. It also provides accuracy, another hidden benefit of the internet. This not only increases speed but also leads to great reductions in waste. Furthermore, depending on the industry and product, it can lead to reductions in inventory costs as products are made to order.