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Up2
Which option below to hedge pension liabilities has the least amount of spread risk?
- A. Received-fixed swaps.
- B. Assets of higher quality than the liabilities.
- C. Futures contracts on the 10-yr US Treasury notes.
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Up5
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-Ã -vis Treasuries.
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