Interest-rate swap traders in Korea are sitting on millions of dollars of mark-to-market losses on proprietary positions that have plummeted in value over the past month. "This shocked the market," said Scott Sohn, manager of interest-rate trading at the Korea Development Bank in Seoul. Traders entered interest-rate swaps--paying fixed and receiving floating--and bought fixed-coupon Korean Treasury bonds to hedge the position. However, the floating rate has crashed.
Traders noted that due to large amounts of exotic bond issuances in Korea, such as callable notes (DW, 4/28) and digital structures (DW, 4/19), as well as an increase in local banks looking to remedy balance sheet mismatches, demand for paying fixed on swaps has greatly outstripped supply. This has prompted a large drop in the price of interest rate swaps-- for example, three-year interest-rate swap levels dropped from 6.70% to 6.21% over the past few weeks, narrowing the spread from the three-year Korean treasury bond rate from 30 basis points to 6 basis points, as the bonds' yield moved from 6.40% to 6.15% over the same period.
"The larger players are probably sitting on at
USD1-2 million loss," said one trader, noting it could possibly be much greater. The largest houses include JPMorgan, Deutsche Bank and KDB but officials at all three declined comment.
"These levels are ridiculous" exclaimed one trader in Korea. Traditionally, the spread between the KDB's bonds and the treasury bonds was around 30 basis points. It is around this level versus the treasury notes where traders put on swap positions, believing it should be in parity. "Everyone's been hurt but you just have to sit on the lossesyou can't get out," said one trader.