Question

The historical yield spread between AAA bonds and Treasury bonds widened dramatically during the credit crisis in 2008. If you believed the spread would soon return to more typical historical levels, what should you have done? This would be an example of what sort of bond swap?

Short answer

Rate anticipation swap; the trade should have been done to long the corporate bonds and short the treasuries.

Step-by-step solution

Definition of bond swap

The sale of a bond to purchase another bond and take advantage of the market conditions is known as a bond swap.

Explanation of a bond swap

This should be an example of a rate anticipation swap. In the given scenario, the trade should have been done too long the corporate bonds and short the treasuries. This should help realize a relative gain when rate spreads return to normal.