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Your analysis indicates that the credit risk (default risk) of (1) a floating rate bond backed by credit card receivables and (2) a fixed rate
Your analysis indicates that the credit risk (default risk) of (1) a floating rate bond backed by credit card receivables and (2) a fixed rate bond issued by a financial company are exactly the same. Table Two shows current market data relating to these bonds. Table Two Current Market Rates Which one of the five trades below would you enter into? Explain your answer. Trade One: Buy $1,000,000 Financial Company Bond, Sell \$1,000,000 Credit Card Backed Bond Trade Two: Buy \$1,000,000 Financial Company Bond, Sell \$1,000,000 Credit Card Backed Bond, Receive LIBOR Interest Rate Swap (\$1,000,000 notional) Trade Three: Buy \$1,000,000 Credit Card Backed Bond, Sell \$1,000,000 Financial Company Bond Trade Four: Buy $1,000,000 Credit Card Backed Bond, Sell $1,000,000 Financial Company Bond, Receive LIBOR Interest Rate Swap ( 1,000,000 notional) Trade Five: Buy $1,000,000 Credit Card Backed Bond, Sell $1,000,000 Financial Company Bond, Receive Fixed Interest Rate Swap (\$1,000,000 notional) The trades are summarized in Table Three. An " X " means an interest rate swap position is taken. Table Three Summary of Trades Your analysis indicates that the credit risk (default risk) of (1) a floating rate bond backed by credit card receivables and (2) a fixed rate bond issued by a financial company are exactly the same. Table Two shows current market data relating to these bonds. Table Two Current Market Rates Which one of the five trades below would you enter into? Explain your answer. Trade One: Buy $1,000,000 Financial Company Bond, Sell \$1,000,000 Credit Card Backed Bond Trade Two: Buy \$1,000,000 Financial Company Bond, Sell \$1,000,000 Credit Card Backed Bond, Receive LIBOR Interest Rate Swap (\$1,000,000 notional) Trade Three: Buy \$1,000,000 Credit Card Backed Bond, Sell \$1,000,000 Financial Company Bond Trade Four: Buy $1,000,000 Credit Card Backed Bond, Sell $1,000,000 Financial Company Bond, Receive LIBOR Interest Rate Swap ( 1,000,000 notional) Trade Five: Buy $1,000,000 Credit Card Backed Bond, Sell $1,000,000 Financial Company Bond, Receive Fixed Interest Rate Swap (\$1,000,000 notional) The trades are summarized in Table Three. An " X " means an interest rate swap position is taken. Table Three Summary of Trades
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