If you expect default correlations to increase in the future,what trade might you engage in to profit from this view?
A)Buy the senior tranche of a CDO.
B)Buy a second-to-default basket option and sell a first-to-default basket.
C)Sell a second-to-default basket option and buy a first-to-default basket.
D)Short the equity tranche of a CDO.

Question

Quizplus · Accepted Answer

When correlations increase,the value of the second-to-default basket increases and that of the first-to-default basket decreases,hence (b)is profitable,and (c)is not.When correlations increase,the senior tranche of a CDO is more likely to experience losses,so that (a)is a wrong answer.When correlations increase,the equity tranche becomes more valuable,and shorting it would be the wrong answer (d).

If You Expect Default Correlations to Increase in the Future,what