Zapped by negative gamma in Japan
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Zapped by negative gamma in Japan

It's all in the price

Shareholder value is a convertible issue

The convertible bond market seems to be proving the dictum that there's no such thing as bad publicity except for your own obituary. The prominent role that Japanese bank convertibles played in equity-derivative losses suffered by UBS last year, and which contributed to the bank's relegation to junior partner in the merger with SBC, has done little to lessen investors' enthusiasm for the product. However, market participants agree that UBS was far from alone in getting its fingers burnt.

"Most convertible arbitrageurs lost money," says Jeremy Howard, head of convertible research at Deutsche Morgan Grenfell. "The question is how much? I don't think many people didn't suffer some pain."

The products that caused the losses are very distinctive, almost a separate asset class. Unlike normal convertibles, conversion of the bonds into equity is mandatory at maturity, so allowing Japanese banks to treat them as tier-one capital. The price at which the bonds can be converted into equity can also be reset periodically should the share price decline.

"Very few people understand resets. Most firms don't even have the models to deal with them," says Daniel Palmer, executive director at Morgan Stanley Dean Witter.

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