Priore believes that credit research should consider the proper pricing of credit risk. He states that basis trades are used by credit investors to ensure that the credit risk of bonds and CDSs is priced appropriately. He provides bond and CDS information for Webster, Hamsco, and Levrom. The current level of Libor is 2.00%.
Exhibit 2
Information for Three-Year Bonds and Three-Year CDSs
Company Bond Yield CDSSpread
Webster 5.00% 3.00%
Hamsco 5.50% 3.25%
Levrom 5.25% 3.50%
Based on Priore’s statement and Exhibit 2, for which of the following company’s bonds is the credit risk compensation likely too low?
- Webster
- Hamsco
- Levrom
Levrom
please explain
The credit risk implied by the bonds is 3, 3.5 and 3.25 respectively and the question asks which bonds compensation is likely low it’s the last bond because it’s cds spread is 3.5 and the bond is giving only 3.25