American Electric Power is evaluating entering a total return swap for the first time and has purchased USD30-40 million (notional) of credit-default protection on one of its counterparties. Total return swaps could be used as a hedging tool when credit derivatives are not available on certain corporates, for example for names which are not liquid, noted an official at the firm in Columbus, Ohio. A total return swap would function similarly to a credit-default swap, by synthetically shorting a bond, with AEP paying the return on the bond and receiving LIBOR plus or minus a spread.
AEP intermittently buys credit protection to hedge its exposure to trading counterparties, said Frank Hilton, v.p. and chief credit officer. He declined to name the reference entity for the recent protection purchase, although noted that it is an energy company. AEP is considering buying swaps on additional counterparties and receives indicative bids regularly, according to Hilton. The net fair value of AEP's trading book at the end of Q1 stood at USD145 million.
Hilton declined to name which firm sold it the protection, noting that the corporate shops around for the best execution.