You manage a European bond portfolio with a target duration of four years. All of your investments are denominated in euros. You have recently been allowed to use credit default swaps to convert riskier corporate bonds into synthetic government bonds. You currently have 10 million euros to invest and you are evaluating the following two new investment opportunities:

(i) A newly issued 5-year zero coupon corporate bond rated A-/A3 priced at 96.81% of par, with par being 1,000 euros. The five-year credit default swap quote for this corporate borrower is 50 basis points p.a.

(ii) A seasoned French Government OAT (i.e., a French Treasury bond) with an annual coupon of 3.5% that matures in five years' time. The price of this bond is 116.13% of par, with par being one euro.

a) Which of these two investment alternatives offers the higher yield? Approximately how much higher?

b) List one additional issue you should consider before investing in a corporate bond plus credit default swap combination of this nature.

Answer rating: 100% (QA)

Investment Comparison a Yield Comparison Option i Corporate Bond with CDS Bond Price 9681 of 1000 96... View the full answer