Convertible bond and equity issuance by European telecoms companies, France Telecom and Royal Dutch KPN, moved credit-default swap spreads in opposite directions last week. Convertible arbitrage funds snapped up France Telecom's EUR3 billion (USD2.64 billion) convertible offering and also bought credit protection to hedge the credit risk and isolate the equity component. This made spreads widen to 160-180 basis points Wednesday from 125-135bps Tuesday. Andy Preston, fund manager at KBC Alternative Investment Management in London, said it bought both the convert and credit protection because the embedded equity option in the convert is priced in the mid-30s vol whereas it is trading at around 50 vol in the equity derivatives market.
The cost of five-year protection on KPN shrank roughly 200bps to 300-325bps Wednesday morning, following its plans to raise EUR5 billion through a share offering. "It is still a vulnerable credit, but it's a lot more improved and the junk concern is no longer there," noted another trader.
