Credit-default swap spreads on Pechiney widened 10 basis points to 120bps last week as convertible arbitrage hedge funds bought protection to strip out the credit risk on the French steel company's convertible bond offering. Pechiney issued a EUR450 million (USD397 million) convertible bond with an embedded equity option priced at 26%. Andy Preston, fund manager at KBC Alternative Investment Management, said he bought the bond and protection to isolate the equity risk. Implied volatility on Pechiney's common stock has not fallen below 27% in the past four years, with an average implied vol of 38-39% over that same time frame, said Preston. Derek Watson, advisor to the convertible arbitrage fund at Decillion Investment Management in Nyon, Switzerland, said he also plans to buy the bond and would isolate the equity option. However, he said it will do this via an asset swap.
Preston estimated there were about 30 convertible arbitrage funds buying credit derivatives to isolate the equity volatility. "The issue has come at a time when sentiment in volatility-related products is low, and things need to be priced to sell," Preston said.
The bonds were launched at par and have a coupon of 1.25%, a yield to maturity of 3.125%-3.625% and a conversion premium of 25-30% at issue.