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Vol Investors Drive CDS Range Accrual Development

23 Dec 2005

Funds looking to play credit volatility have been asking dealers to adapt a popular interest rate and equity structure--the range accrual--into credit.

Funds looking to play credit volatility have been asking dealers to adapt a popular interest rate and equity structure--the range accrual--into credit. A handful of credit range accrual notes have been priced by houses such as Deutsche Bank and JPMorgan on a bespoke basis, officials said. Other European houses including ABN AMRO are eyeing the structure.

Demand for the notes is tipped to take off next year and could open the credit derivative gates to retail investors, who are frequent users of range accruals in the equity and rates arenas, and also real money accounts. "They can enhance return on existing positions by using the accruals as an overlay," said Marcus Schüler, managing director in integrated credit marketing at Deutsche Bank in London. "This is definitely a topic on the credit derivative agenda." Another trader said CDS range accruals would appeal to players wanting to take a view on credit without going long default risk.

CDS range accruals will feature top and bottom bounds and pay a coupon which accrues based on how long spreads in a specific credit index remain within that range, said Costas Katsileros, credit options trader at ABN in London. He predicted three- and five-year structures linked to the five-year index will be the most popular. Put and call options will be used to cap and floor the spread range.

But, critics say CDS range accruals won't become common until daily tradable fixings on the indices are introduced. Presently only weekly fixings exist but on the flip side, there are several different ways the structures can be put together. They could be linked to spread movements of single name CDS, the indices or constant proportion portfolio insurance to provide capital protection.

23 Dec 2005