- Interestingly Merrill's partial financing of the purchase essentially constitutes a put underwritten by MER on its CDO exposure
- However, the short put represents only one leg of a complex three-part transaction which synthetically results in Merrill’s purchase of a protective put-spread for its CDO.
CDO sale = long ATM put
75% financing of purchase = short OTM put
Wednesday 30 July 2008
Monday 28 July 2008
Meltdown in Europe :Indicators point towards a worsening. Markets for the week ending 25-Jul.
Market commentary:
- Gains in financials continued as Citigroup Inc., JPMorgan and Bank of America Corp., reported second-quarter earnings that beat analysts' estimates. Investors are hopeful this may be the real thing, seeing a glimmer of hope within the financials.
European Outlook:
- German Finance Ministry reported that GDP shrank "considerably" in the second quarter and estimates to be released in August. Significantly deteriorating German business climate and outlook suggests that the economic upswing is coming to an end.
- Spain's manufacturing PMI set a new record low --> indicators point to Q2 growth around 0.2% q/q and then turn negative
- Ireland: Economic and Social Research Institute forecast that GDP growth in Ireland will be negative in 2008 at -0.4% from 5.3% growth in 2007. The Irish economy is likely to face its first recession since 1983 as the slump in housing construction is likely to wipe out all growth in rest of the economy
- The UK economy grew 0.2% in the second quarter of the year, as the credit crunch took its toll on the housing market and consumer spending. The figure is the lowest growth quarter-on-quarter for three years.
UK Banking
After a ridiculous rally in UK banks over last week's sessions from a very low level, we will soon have a better picture in the next couple of weeks as to their health.
(interim reporting period starting with Lloyds on Wednesday)
Scenarios:
A) over a year of writing off debt, market believes that they must be somewhere near the bottom
B) further credit writedowns as signaled by Citigroup cutting European banks to "underweight" from "neutral"
Interesting note:
In the four bear markets since 1973, rallies of 10 percent or more lasted an average of 54 days for a gain of 14.5 percent.
In every case, the S&P 500 fell again, dropping an average of 21.5 percent over 114 days.
The same pattern this time would send the S&P 500 to a peak in September before giving way to a slump that would continue until the start of 2009.
Eric Tan, London
- Gains in financials continued as Citigroup Inc., JPMorgan and Bank of America Corp., reported second-quarter earnings that beat analysts' estimates. Investors are hopeful this may be the real thing, seeing a glimmer of hope within the financials.
European Outlook:
- German Finance Ministry reported that GDP shrank "considerably" in the second quarter and estimates to be released in August. Significantly deteriorating German business climate and outlook suggests that the economic upswing is coming to an end.
- Spain's manufacturing PMI set a new record low --> indicators point to Q2 growth around 0.2% q/q and then turn negative
- Ireland: Economic and Social Research Institute forecast that GDP growth in Ireland will be negative in 2008 at -0.4% from 5.3% growth in 2007. The Irish economy is likely to face its first recession since 1983 as the slump in housing construction is likely to wipe out all growth in rest of the economy
- The UK economy grew 0.2% in the second quarter of the year, as the credit crunch took its toll on the housing market and consumer spending. The figure is the lowest growth quarter-on-quarter for three years.
UK Banking
After a ridiculous rally in UK banks over last week's sessions from a very low level, we will soon have a better picture in the next couple of weeks as to their health.
(interim reporting period starting with Lloyds on Wednesday)
Scenarios:
A) over a year of writing off debt, market believes that they must be somewhere near the bottom
B) further credit writedowns as signaled by Citigroup cutting European banks to "underweight" from "neutral"
Interesting note:
In the four bear markets since 1973, rallies of 10 percent or more lasted an average of 54 days for a gain of 14.5 percent.
In every case, the S&P 500 fell again, dropping an average of 21.5 percent over 114 days.
The same pattern this time would send the S&P 500 to a peak in September before giving way to a slump that would continue until the start of 2009.
Eric Tan, London
Downshift in global growth momentum. Markets for week ending 18-Jul.
- The coincidence of combined financial, commodity, and more recently corporate profitability shocks continues to hammer the global economy.
- Global growth having held up above trend for the last few years is now bringing serious capacity constraints to the global economy.
- Unwinding of the above constraints is rarely gradual or smooth, which suggests that a rapid deterioration is likely to lead to an intensification of the global slowdown well beyond baseline scenarios.
- We are now witnessing negative second round effects through trade flows.
U.K. inflation climbed 3.8 percent from a year earlier, more than economists forecast in June to the fastest pace in at least 11 years.
The high inflation number exceeds the government's 3 percent upper limit for a second month, putting pressure on the Bank of England to avoid cutting interest rates as the threat of a recession looms.
Short-run policy implication: unchanged fed funds rate for some time
Bernanke’s semi-annual Monetary Policy Report to Congress on Tuesday is that the FOMC views the current 2.0% Fed funds rate as appropriately calibrated to restoring acceptable growth and acceptable inflation over the medium-term given the information available today ?
Eric Tan, London
- Global growth having held up above trend for the last few years is now bringing serious capacity constraints to the global economy.
- Unwinding of the above constraints is rarely gradual or smooth, which suggests that a rapid deterioration is likely to lead to an intensification of the global slowdown well beyond baseline scenarios.
- We are now witnessing negative second round effects through trade flows.
U.K. inflation climbed 3.8 percent from a year earlier, more than economists forecast in June to the fastest pace in at least 11 years.
The high inflation number exceeds the government's 3 percent upper limit for a second month, putting pressure on the Bank of England to avoid cutting interest rates as the threat of a recession looms.
Short-run policy implication: unchanged fed funds rate for some time
Bernanke’s semi-annual Monetary Policy Report to Congress on Tuesday is that the FOMC views the current 2.0% Fed funds rate as appropriately calibrated to restoring acceptable growth and acceptable inflation over the medium-term given the information available today ?
Eric Tan, London
Friday 11 July 2008
Another deleveraging scenario this summer? Markets for the week ending 10-Jul
Market Update: Standard & Poor's 500 Index fell into a bear market
The benchmark index for American equities plunged to a two-year low on Tuesday, bringing the loss since its October record to 20 percent.
Shares have been declining for five straight weeks, and a drop in the index of another 12 percent would match the average retreat of 11 bear markets since 1946.
Reasons suggesting another deleveraging scenario this summer:
- Nervous investors sell bonds, driving prices down; Traditional bond managers may start losing their clients if they have another poor quarter.
- Hedge-fund managers may find prime brokers cutting off funding if their positions deteriorate.
- Bank loans have been contracting at an annualised rate of 8% over the past 13 weeks to June 25th.
- Fundamentals for the corporate-bond market have worsened since last August.
- Expectations for corporate profits are being revised down, as margins come under pressure from slower growth and higher commodity prices.
- Headline inflation is well above target, so central banks are unlikely to ride to the rescue with interest-rate cuts, preferring to tighten monetary policy.
? Sell Signal : Financials
Fannie Mae, Freddie Mac, speculations runs rife
- Rising borrowing costs spurred concern that America's biggest sources of home-mortgage financing may not be able to fund their businesses.
- Fannie Mae and Freddie Mac fell to their the lowest since 1992.
With $5.2 billion more owed than its assets were worth in the first quarter, Freddie Mac would be technically insolvent under fair value accounting rules.
Implications:Until investors see what write-offs are going to be and second-quarter earnings of financial companies, they're not interested in buying at any price.
Word on the street is that it's been far too early to buy and the loan-loss reserves need to stabilize before investors return to the markets.
Worth noting:
Lehman-LEH put volume & volatility Spike; LEH down 12%
LEH is recently down $2.54 to $17.20. LEH call option volume of 15,588 contracts compares to put volume of 41,549 contracts.
LEH July option implied volatility is at 188, August is at 170; above its 26-week average of 75, suggesting larger risk.
Earnings announcements:
JPM : 17-Jul
MER : 17-Jul
Citigroup : 18-Jul
Eric Tan, London
The benchmark index for American equities plunged to a two-year low on Tuesday, bringing the loss since its October record to 20 percent.
Shares have been declining for five straight weeks, and a drop in the index of another 12 percent would match the average retreat of 11 bear markets since 1946.
Reasons suggesting another deleveraging scenario this summer:
- Nervous investors sell bonds, driving prices down; Traditional bond managers may start losing their clients if they have another poor quarter.
- Hedge-fund managers may find prime brokers cutting off funding if their positions deteriorate.
- Bank loans have been contracting at an annualised rate of 8% over the past 13 weeks to June 25th.
- Fundamentals for the corporate-bond market have worsened since last August.
- Expectations for corporate profits are being revised down, as margins come under pressure from slower growth and higher commodity prices.
- Headline inflation is well above target, so central banks are unlikely to ride to the rescue with interest-rate cuts, preferring to tighten monetary policy.
? Sell Signal : Financials
Fannie Mae, Freddie Mac, speculations runs rife
- Rising borrowing costs spurred concern that America's biggest sources of home-mortgage financing may not be able to fund their businesses.
- Fannie Mae and Freddie Mac fell to their the lowest since 1992.
With $5.2 billion more owed than its assets were worth in the first quarter, Freddie Mac would be technically insolvent under fair value accounting rules.
Implications:Until investors see what write-offs are going to be and second-quarter earnings of financial companies, they're not interested in buying at any price.
Word on the street is that it's been far too early to buy and the loan-loss reserves need to stabilize before investors return to the markets.
Worth noting:
Lehman-LEH put volume & volatility Spike; LEH down 12%
LEH is recently down $2.54 to $17.20. LEH call option volume of 15,588 contracts compares to put volume of 41,549 contracts.
LEH July option implied volatility is at 188, August is at 170; above its 26-week average of 75, suggesting larger risk.
Earnings announcements:
JPM : 17-Jul
MER : 17-Jul
Citigroup : 18-Jul
Eric Tan, London
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