In the topic test, the question asks about derivatives to hedge credit risk. The are three choices, credit spread option, credit spread forward , or binary credit option. The answers says portfolio must be protected from downgrade risk, thus requiring the use of a binary credit put option that pays the holder if the bond’s rating falls below investment grade. I think credit spread option and forward can protect from downgrade risk too. ?
Spread options and spread forwards primarily protects investors from large movements of IRs thus hedge IR risk.
Binary options and CDS (not mentioned in question) protect investors from rating downgrade.
Ah, thank you.