The current credit spread on bonds issued by Great Foods Inc. is 300 bps. The manager of More Money Funds believes that Great Foods’ credit situation will improve over the next few months, resulting in a smaller credit spread on its bonds. She decides to enter into a six-month credit spread forward contract, taking the position that the credit spread will decrease. The forward contract has the current spread as the contracted spread, a notional amount of $10 million, and a risk factor of 5.
A. On the settlement date six months later, the credit spread on Great Foods bonds is 250 bps. How much is the payoff to More Money Funds?
B. How much would be the payoff to More Money Funds if the credit spread on the settlement date is 350 bps?
C. How much is the maximum possible gain for More Money Funds?