Merrill Lynch last week launched Pacific Rim capital structure arbitrage coverage, which it believes is one of the first for the region. "Previously in Asia there was no systematic way that incorporated information on equity, options and credit in one single place," said Girish Kumar, director of Asian convertibles research at Merrill in Sydney. Capital structure ideas focus on diverging or converging valuations of a firm's equity, credit and equity options. "Japan and Asian markets are becoming liquid enough to trade CDS and equity options," he added.
In an example trade, Merrill is recommending buying call options or buying the underlying stock of Korea's KT Corp., a stock the firm believes is under-priced. Simultaneously, it suggests purchasing five-year credit-default swap protection because down the road KT's success may prompt it to buy back stock or enter an acquisition, which would increase credit risk and cause the spread to widen. Kumar continued that the firm is looking at a broad array of end users for such trades, not just hedge funds. "Even institutional long equity players should get a sense of where the credit is trading and pick up that edge."
