Merrill Creates Low Vol First-To-Default Basket

  • 21 Oct 2002
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Merrill Lynch has started marketing a new breed of first-to-default baskets designed to give investors a yield pick up by selecting "boring credits" with low vol rather than moving down the credit curve. As volatility in the credit markets has increased, investors, including insurers, fund managers and pension funds, have been asking for products with less volatility, said Chris Francis, head of international credit research at Merrill in London. Rather than moving down the credit curve and investing in higher yielding credits, investors can sell protection on names that lie in the middle of the total return distribution. "We are trying to point out which are the boring companies in the middle," Francis said.

The product is research-driven with Merrill suggesting its first basket of five names--DaimlerChrysler, GKN Holdings, Lafarge, Pearson and Telecom Italia. The basket consists of credits from different industry sectors and different parts of the world, which means they have a relatively low correlation, Francis said. This provides the seller with the highest amount of leverage. The premium on the basket is 423 basis points, which offers 2.6 times the maximum default premium on any single name within the basket. The basket has a credit rating of mid BBB, according to Standard & Poor's weakest link approach.

  • 21 Oct 2002

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