Credit Spread Options in Managing Credit Risk

Very Hard Risk Management Credit Risk Management

Valeria is a senior portfolio manager at a wealth management firm overseeing a large fixed income portfolio, predominantly invested in corporate bonds. Recently, she has been concerned about rising interest rates and their impact on credit risk. To mitigate potential credit risk in her portfolio, she is contemplating the implementation of a credit spread option strategy. Valeria wants to assess how this strategy could protect her against a deterioration in credit quality among the securities she holds.

Which of the following statements best describes the implications of implementing a credit spread options strategy in the context of managing credit risk?

A credit spread options strategy allows investors to profit from tightening credit spreads while providing limited downside protection against widening spreads.

This strategy primarily protects against event risk and does not have significant implications for overall credit exposure.

The strategy involves purchasing credit spread options to hedge against the risk of credit deterioration, effectively providing a form of insurance against defaults.

Hint

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