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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: macavity who wrote (6128)	5/20/2002 12:12:58 PM
From: John Pitera	Respond to of 33421

Good Answer Mac, the Black Scholes option valuing model works to determine fair value of ESOP's. It's definitely possible to figure out what it would cost to buy a similar option plan.

To: macavity who wrote (6128)	5/20/2002 1:08:26 PM
From: John Pitera	Respond to of 33421

WORLDBONDS-A weather vane of credit conditions (If the logic of this article prevails, it will be interesting to see the unwind from all of the floating rate positions into fixed rate profiles. JP) biz.yahoo.com -------------- By Aleksandrs Rozens Monday May 20, 8:02 am Eastern Time Reuters Market News WORLDBONDS-A weather vane of credit conditions NEW YORK, May 20 (Reuters) - Interest rate swaps, once a barometer of credit conditions, may have lost some of theirpredictive ability because they are being used more frequently by a wider variety of financial professionals. Swaps are financial tools that allow banks and corporations to manage interest rate risk. Swap spreads -- the difference between swap rates and Treasury rates -- were initially viewed as a measure of credit conditions because they represented the risk of AA-rated financial institutions. If swap spreads widened, the implication was that credit conditions were uncertain. Conversely, narrower swap spreads meant a drop in worries about credit conditions. These days, though, interest rate swaps march to a different beat, largely because they are increasingly used to hedge interest rate risk by mortgage investors and corporations. There is no way to strain out the influence of these outside factors, leaving some market players to wonder if a traditional credit barometer has not been skewed. The best example of the disconnect between credit conditions is evident when comparing swap spreads and corporate debt spreads, the premium over Treasury yields paid to investors. Swaps have narrowed steadily this year to levels not seen since prior to Russia's 1998 debt default, which roiled Wall Street. Narrower swap spreads -- on the surface -- would suggest rosy credit conditions for banks and corporations. But wider corporate debt spreads and corporate casualties like Enron Corp. (Other OTC:ENRNQ.PK - News) paint a different picture. According to Merrill Lynch & Co., investment grade corporate debt spreads have pushed out to 186 basis points from 162 basis points late last year. At the same time, 10-year swap spreads have narrowed to 52-1/2 basis points from 75 basis points late last year. These current spreads are in marginally from 55 basis point levels on the eve of Russia's default, according to a trader with a dealer firm. "Swaps are used more as an asset liability or duration management tool," said George Oomman, interest rate derivatives strategist at Credit Suisse First Boston. MORTGAGE PLAYERS USE SWAPS Since 1998, investors have increasingly relied on the swaps market to hedge their mortgage bond holdings. Prior to the 1998 crisis, Treasuries were the hedge of choice. But this changed when a safe-haven bid for U.S. government bonds in that crisis <b.disconnected Treasuries from the rest of the fixed income world. Smarting from the crisis, investors in the world's largest credit market -- the U.S. mortgage bond market -- relied increasingly on interest rate swaps to manage the duration of their mortgage bond investments. Mortgage bond holders are not the only market players using debt swaps as hedges. Mortgage lenders and loan servicers use them to protect their massive loan servicing businesses. A decline in rates eats away at the value of mortgage portfolios, so investors buy back duration lost by declines in rates by receiving fixed payment flows in swap agreements. This results in tighter swap spreads. "Particularly, the mortgage investor community has moved increasingly to swap-based hedges for their mortgage portfolios. That has dominated the flows in the swaps market, particularly during the first two quarters of last year," said Oomman. CORPORATES LIKE SWAPS TOO At the same time, the shape of the debt swaps curve -- the difference between short- and long-term swap rates -- has made it cost-effective for large companies to issue debt and swap it in the short-end of the interest rates swaps mart. Countrywide Home Loans, Inc. a unit of Countrywide Credit Industries, Inc.(NYSE:CCR - News), is just one a business to tap the swaps market. On May 14, the company sold $1 billion of five-year corporate debt and swapped it into into floating rates. "Companies issue fixed-rate debt and convert it from fixed to floating rate," said Oomman. "In the current low-rate and steep-yield-curve environment, short-term money is significantly lower," he said, adding that as long as the swaps curve is steep, corporations will continue to issue term debt and swap it to floating rate. BLOSSOMING GOVERNMENT DEBT TUGS SPREADS IN In addition to mortgage-related hedging and demand related to corporate debt hedging, swap market players say spreads of swaps have been tugged in by another factor -- the blossoming budget deficit. The budget deficit -- and the implicit pickup in issuance by the U.S. Treasury -- has sent Treasury yields higher and likely will keep them at higher levels. Prior to 1998's crisis, the U.S. government was trimming spending, but it had not started the buyback of government debt, which sent U.S. Treasury yields lower. Now, participants believe Treasury yields are sure to climb as government spending picks up, narrowing the spread between swap rates and Treasury yields. biz.yahoo.com