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The Industrial Bank of Japan is structuring what is considered to be the first exotic weather derivative purchased by a Japanese gas company. "It's the first of its kind in Japan," said Hiroshi Matsui, senior manager of derivatives and fixed-income in Tokyo, pointing out that the deal combines weather, oil price and foreign exchange risk. He declined to name the counterparty.

Henderson Global Investors is planning on becoming a more active buyer of synthetic securities following the implementation of an in-house derivatives model that will allow it to compare values in the cash and synthetic markets. Daniel Beharall, head of the quantitative portfolio management team in London, said when the proprietary system is implemented, "we will really be cranking up what we're doing." Henderson manages roughly GBP11 billion (USD15.7 billion) in credit and he said, roughly speaking, the firm could have up to 10% of that in synthetic assets once the system is implemented, assuming market conditions are right. Currently Henderson has only a handful of single-name default positions.

Hong Kong-based Gold Peak Industries (Holdings), a multinational involved in industrial investments, technology and batteries, is considering entering interest-rate swaps for the first time to hedge interest-rate exposure on its HKD1 billion (USD128 million) floating-rate loan portfolio, of which the majority is U.S. dollar LIBOR-based. "We're considering proposals," said Barry Ho, manager in the finance department.

France Telecom's latest convertible bond offering has confused some European credit derivatives traders by once again bringing up the issue of whether convertibles can be delivered to holders of credit-default swaps in the event of a default. This time the issue revolves around the fine print on the EUR3.5 billion (USD3.1 billion) convertible bond the telecom giant issued last month. Some traders said convertibles from the deal should not be treated as deliverable because of a caveat in the deal's documentation, while others said the market appears to be treating the convertibles as deliverable and has ignored the fine print. Five-year default protection on the telecom company widened about 50 basis points to 180bps on news of the convertible, partly on the assumption it would be deliverable in a credit event.

One-month euro/U.S. dollar implied volatility rose to 10.55% last Wednesday from 10.05% a week earlier, as demand for euro calls/dollar puts picked up as bulge bracket firms adjusted their positions before the holiday season. Investment banks were the most active in the market, buying up one-week euro calls/dollar puts as the one-month 25-delta risk reversal moved further in favor of dollar puts, according to New York-based traders. Most of the options were at-the-money and had strikes around USD0.89.

The Japanese government and major Japanese banks, such as the Bank of Tokyo-Mitsubishi and Sumitomo Mitsui Banking Corp., saw their credit ratings downgraded by Fitch Monday, prompting a flurry of trades in the credit-default swap market. "Things are absolutely crazy," said Ralph Orciuoli, managing director of structured credit products at Bank of America in Tokyo, noting that volumes on the sovereign surged to around USD100 million per day early last week from USD30-50 million in a typical week. Spreads on 10-year protection on the sovereign jumped from 27-32 basis points to 33-37bps last Wednesday, he noted.

Credit-default swaps are well established in the debt market as hedging instruments against credit risk and to enable market participants to establish a synthetic short position in a specific reference credit and implement credit-trading strategies outside the cash markets. The most common method of pricing default swaps is by recourse to the asset-swap spread of the reference credit, as the default-swap premium should, in theory, be equal to the asset-swap spread of the reference asset. We first consider the use of this technique, before looking at the issues arising that cause these two spread levels to differ.

Five-year credit-default protection on Nokia continued to tighten last week, outpacing its European mobile peers as strong collateralized debt obligation bids pushed in credit spreads on the world's largest handset maker. Nokia had tightened about five basis points to roughly 30-40bps last week, prior to an Enron-induced widening which pushed the entire European market out five basis points further. Traders said Nokia had tightened considerably in the last two weeks or so, as a handful of structurers assembling CDO assets picked the credit. "Investors don't like Ericsson and Alcatel anymore, but because of diversification requirements you need telecom in there and Nokia has become a real favorite," said one. At its widest earlier in the year, Nokia traded at 70bps, while Alcatel was at 360bps. The entire sector has tightened, but Nokia has come in about 60% in comparison to Alcatel's 30.

Interest-rate traders expect volumes in the Asian interest-rate markets, particularly in Hong Kong, Singapore and Korea, to surge after New Year, as customers enter derivatives on the belief that rates are bottoming out. "There will be a dramatic pickup," said Rinesh Mehta, exotic and plain-vanilla options trader at BNP Paribas in Singapore, adding, "volumes in the [Asian] option markets will increase by 50-75%." Average daily volume in the Hong Kong interest-rate options market is currently around USD3-400 million. Mehta continued that corporates, which have been on the sidelines waiting for rates to bottom-out, have started inquiring about entering interest-rate derivative transactions at the onset of 2002.

Lehman Brothers is advising clients to follow a stock replacement strategy that utilizes call options to replace some or all stock positions, which have rebounded from the effects of the slowing U.S. economy and the impact of the Sept. 11 attacks. Investors who think the U.S. equity market may crash before year-end should opt for this trade, according to, Paul Lieberman, v.p. of equity derivatives and quantitative research in New York. He explained it locks in the stock gain by selling some of the stock and maintains upside exposure with the rest. Being a defensive strategy the loss in the call option is limited to the premium paid, he added.

Fortis Bank Hong Kong is reorganizing its derivatives effort following the resignation of Tony Au, head of capital markets in Hong Kong, two weeks ago. Philippe Dirckx, head of interest-rate derivatives in Hong Kong, has been promoted to head of fixed income and has assumed Au's responsibilities. "We're in the middle of a restructuring phase but next year our focus will be on credit derivatives products," said Dirckx.

Traded volumes of credit-default swaps referenced to Enron's financial backers J.P. Morgan Chase and Citigroup increased five fold on Thursday amid concerns that Enron was going to file for bankruptcy. The activity picked up after the two firms announced their decision to invest an additional USD500 million between them in the company that would be created were Enron and Dynegy to merge. They have already invested USD1 billion. Officials at the firms confirmed the investments.