In a research report last week, Morgan Stanley's ABS research team examined the relative value of combining a double-A/double-B plus trade, versus a standalone triple-B minus trade in the home equity sector, showing that on both a credit adjusted and option adjusted spread basis, the double-A/double-B plus combination enhances yield and improves the default risk profile compared to buying triple-B minus bonds alone.

The reasoning behind the trade is that a substantial boost in yield can be gained by going only one notch lower than triple-B minus in the capital structure to a double-B plus credit, while hedging credit exposure by moving up seven notches to the double-A bond. For the triple-B minus trade, Morgan Stanley used the weighted average spread for a typical mezzanine ABS CDO, with a triple-B WARF for assets, and for the double-A/double-B plus trade the firm used a sub-investment grade ABS CDO, with a double-B plus WARF for assets.

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