A client observes that a corporate bond that he is interested in purchasing with a triple A rating has a benchmark spread that is positive when the benchmark is U.S. Treasuries but negative when the benchmark is the LIBOR curve
The client asks you why. Provide an explanation.
The LIBOR or swap curve reflects more risk than the U.S. Treasuries benchmark curve which is a default-free yield curve. In brief, the LIBOR curve reflects inter-bank credit risk. Unlike
a country's government bond yield curve, the swap curve reflects the credit risk of the counterparty to an interest rate swap. Thus, this creates the possibility of a large enough credit risk that can explain why the client observes that a corporate bond with a triple A rating has
a negative benchmark spread when the benchmark is the LIBOR curve.
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