hard · Debt Capital Markets secondary-trading-liquidity
A dealer must sell a $250mm block of an off-the-run 7y corporate bond into a stressed market. The on-the-run equivalent trades at a 2bp bid-ask, the off-the-run at 8bp. The PM proposes hedging with on-the-run CDX IG to 'lock in' execution while working the block over a day.
Which consideration most sharply determines whether this hedge improves the realized exit versus simply selling into the bid?
- Idiosyncratic and cash-CDS basis risk dominate: the hedge neutralizes systematic spread moves but the off-the-run cash bond can cheapen on a widening basis and name-specific selling, so the hedge protects the wrong risk if the loss is liquidity/basis-driven rather than market-wide.
- Because CDX has a 2bp bid-ask and the bond 8bp, the hedge is automatically cheaper to trade and therefore always improves the exit regardless of how the basis moves.
- The hedge is irrelevant since selling the whole block immediately at the 8bp bid eliminates all risk, making any overlay pure cost and slippage.
- One-day carry on the CDX short is the deciding factor, and as long as that carry is positive the hedge improves the realized exit on the block.
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