The widow-maker

6 May 2005

Some funds thought GM s bonds overreacted to its notorious profit warning. They bought the credit, shorting stock to hedge the position. This capital structure arbitrage ploy has suffered a double whammy: GM s early junking; and Kirk Kerkorian s raid on the stock.

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Several hedge funds have been burned on a capital structure arbitrage trade involving the carmaker General Motors, people familiar with the situation said.

The trade involved buying longdated GM's bonds and simultaneously selling short GM shares.

The hedge funds thought the bond market had overreacted to GM's profit warning in March. They were betting on the company selling its finance arm, cutting its dividend and taking a onetime charge against earnings to fund a restructuring of its automotive operations. This would benefit GM's debt at the expense of its equity.

The short equity position was also intended to hedge the funds against any unexpected deterioration in the credit.

GM's bond prices plunged on Thursday after Standard & Poor's downgraded the credit to junk. While the stock price also suffered, it only gave back a small part of the big gains made earlier this week after billionaire investor Kirk Kerkorian bid to raise his equity stake in GM to 9%.

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