Given that the credit spreads will widen significantly and all interest rates will decline significantly, why should one expect negative effect on the position below? Assume the trade involves buying and selling an equal value of fixed income securities with identical characteristics, except as noted.
Buy 7-year Ba2/BB industrial corporate bonds
AND
Sell 7-year Baa3/BBB industrial corporate bonds
I should think that spreads on lower quality bonds would widen more than spreads on higher quality bonds. Thus, the Ba2 bonds should fall more in price than the Baa3 bonds when interest rates rise, and rise less in price than the Baa3 bonds when interest rates fall. (Note: this is assuming that their durations are similar; if there is a significant difference in their coupon rates, that’s not a valid assumption.)
BB should increase in price less than BBB will. Shorting the bond that increases in price more than the long bond will have a negative net effect.