The historical yield spread between the AA bond and the AAA bond has been 25 basis points. Currently the spread is only 9 basis points. If you believe the spread will soon return to its historical levels, you should ________.

Question

Quizplus · Accepted Answer

If the spread is currently lower than its historical level, the trader should anticipate it to revert to the mean. To profit from this prediction, the trader should buy the cheaper security (AAA) and short the more costly one (AA). By doing so, they will benefit from the spread widening and returning to its historical average.

The Historical Yield Spread Between the AA Bond and the AAA