KBC Alternative Investment Management (B): Capital Structure Arbitrage

Published 10 Jan 2004
Reference 5225
Industry Venture Capital
Region Europe
Summary

Case B: Based on a Merton-type structural model of credit risk, Steve Dash, a trader at KBC AIM, perceives that British Airways’CDS are mispriced relative to the company’s share price. Steve has to figure out which trades to put on to exploit the potential mispricing and what the main profit drivers of this strategy are. At the same time, he needs to be aware of the risks of his strategy and whether the “mispricing” could be attributable to factors that his capital structure arbitrage modedl isn’t able to capture.

Teaching objectives

The teaching objectives are to illustrate capital structure arbitrage as a strategy exploits mispricing between debt (bonds or CDS) and equity based on a Merton model of a credit risk. Link to convertible bond arbitrage.

Keywords
  • Convertible bond
  • Arbitrage
  • Hedge fund
  • Volatility
  • Credit derivatives
  • Debt-equity trading
  • Merton models
  • Credit risk