Question of the Week: Level 3 – Fixed Income (2)

The correct answer is Option A. 

Both Option B and Option C result in Asset BPV derived from government bonds.  Movements in the corporate – Treasury yield spread introduce risk to the hedging strategy. Usually, yields on high-quality corporate bonds are less volatile than on more-liquid Treasuries.

For Option A, the spread risk is between high-quality corporate bond yields (the pension liabilities) and swap rates. Typically, there is less volatility in the corporate/swap spread than in the corporate/Treasury spread because both Libor and corporate bond yields contain credit risk vis-à-vis Treasuries.