KBC Alternative Investment has bought credit protection on Pinault-Printemps-Redoute , a French distributor of luxury goods, as part of a convertible arbitrage strategy. Andy Preston, fund manager, said it bought a credit-default swap referenced to the French corp. and has a long position in a EUR1.3 billion (USD1.16 billion) convertible bond the company issued two weeks ago. The hedge fund's net position is long an equity call option on PPR, since it has hedged out the credit risk. The option allows the fund to convert the bond into equity at any price. However this would only make sense if the share price multiplied by the number of shares per bond was greater than the price of the bond, for this issue the level is EUR140.5, according to Preston.
The equity option was trading approximately seven vol points above an equivalent plain-vanilla call on Tuesday. To cash in on the position the fund can either sell an equivalent option or delta hedge the underlying and hold the option to maturity. The coupon on the convertible bond is 1.5%. The share price was EUR133 Tuesday.
Preston added that since Sept. 11 there has been heavy issuance of convertible bonds in the U.S. and the supply in Europe has also picked up, which should mean this is a good year for convertible arb funds, according to Preston. The KBC fund took on approximately USD100 million more of funds at the beginning of November. The fund now has USD300 million under management.
