1 Characteristics of Convertible Bonds Equity + Bond
2 Convertible bonds Combination of bonds and equities bond plus a call option on stock * bondholder has the right to convert the bond into common shares at some contractual price (conversion number may change over time) Holder s perspective: Issuer s perspective: take advantage of the future potential growth of issuer s company raise capital at a lower cost by the provision of conversion privilege to bond holders convertible bond price conversion premium conversion value straight bond value stock price
3 Equity perspective on convertibles To take advantage of the upside potential growth of the underlying stock (participation into equity). Swapping the variable stock dividends in return for fixed coupon payments until the earlier of the maturity date and the conversion date. Fixed income perspective on convertibles Provides the bond floor value. Call option that allows the investor to exchange the straight bond for fixed number of shares.
4 Call terms Issuer has the right to call back the bond at a pre-specified call price prior to final maturity, usually with a notice period requirement. Upon call, the holder can either convert the bond or redeem at the call price. To be used as a tool by issuer for possible future equity financing.
5 Issuer s perspective on the call right To have the flexibility to call if they think they can refinance the debt more cheaply. To force bondholders to convert debt into equity, which can reduce debt levels and result a beneficial effect on the balance sheet. The issuer has the flexibility to shift debt into equity to reduce the leverage of the firm.
6 Call protection Hard (or absolute): To protect the bond from being called for a certain period of time. Soft (or provisional): To allow the issuer to call under certain circumstances. For example, the closing price of stock has been in excess of 150% of the conversion price on any 20 trading days within 30 consecutive days.
7 Role of call protection To preserve the value of the equity option for the bondholders. While waiting for the stock price to increase, convertibles typically provide more income than the stock. Without the call protection, this income stream could be called away at any time.
8 Put feature Allows the holder to sell back the bond to the issuer in return for a fixed sum. Usually, the put right lasts for a much shorter time period than the maturity date of the bond. The holder is compensated for the loss in coupons received in case the equity portion of the convertible has low value. It protects the holder against rising interest rates by effectively reducing the year to maturity. The convertible s price then becomes less sensitive to interest rate. Euro markets have used the put feature more extensively due to the European experience of inflation.
9 Put above par value Renong Berhad (a Malaysian company) issued a 5-year bond with a 2.5 percent coupon with yield-to-put at 7.5 percent and a put price of Investors perspective Even if the conversion turns out to be unprofitable, they are guaranteed a 7.5 percent return to the time of the put. Premium redemption at maturity At maturity, the bond is redeemed for a price higher than par this results in increased downside protection and lower downside risk.
10 Convertible bond issued by the Bank of East Asia US$250,000, percent Convertible Bonds due 2003 Issue date July 19, 1996 Issue price 100 percent of the principal amount of the Bonds, plus accrued interest, if any, from July 19, 1996 (in denominations of US$1,000 each) Conversion period From and including September 19, 1996 up to and including July 7, 2003 Conversion price HK$31.40 per Share and with a fixed rate of exchange on conversion of HK$ = US$1.00. The Conversion Price will be subject to adjustment for, among other things, subdivision or consolidation of the Shares, bonus issues, right issues and other dilutive events.
11 Put feature Redemption at the option of the bondholders On July 19, 2001, The Bonds may be redeemed at the option of the Bondholders in US dollars at the redemption price equal to percent of the principal amount of the Bonds, together with accrued interest.
12 Call feature Redemption at the option of the bondholders On or after July 19, 1998, the Issuer may redeem the Bonds at any time in whole or in part at the principal amount of each Bond, together with accrued interest, if for each of 30 consecutive Trading Days, the last of which Trading Days is not less than five nor more than 30 days prior to the day upon which the notice of redemption is first published, the closing price of the Shares as quoted on the Hong Kong Stock Exchange shall have at least 130 percent of the Conversion Price in effect on such Trading Day.
13 Case study of market manipulation on conversion China Travel (a red chip company) issued a convertible bond with coupon rate 4.25% per annum in Nov., 1993, near the peak of 1993 bull market, with maturity date in Nov., The conversion price is HK$3.66. Market background Stock price jumped from HK$1.24 at the beginning of 1996 to HK$6.1 on 11 Aug., 1997 (historical high). Since the share price was overvalued, so the management had a strong incentive to convert the debt into equity.
14 Possible market manipulation China Travel owned more than 30% of its company s total shares, and the red chip stocks were widely held by other red chip companies. Therefore, it was relatively easy to push up the share prices in bull market situation. Constraint on calling The daily closing stock price had to stay over HK$5.49 (call price = 150% x conversion price) for more than 20 of the 30 consecutive trading days. This provision makes market manipulation more difficult and easily detectable.
15 Failed attempt of conversion On 6 Aug., 1997, the share price went above the call price for the first time and managed to stay above for 17 trading days. In Sept., 1997, the share price stayed above the call price for two more days (only one day short of the call requirement). Unfortunately, the share price went down under the general market s big drop. Within two months after the failed attempt, the share price dropped below HK$3.66, and within one year, it fell below HK$1.0. The share price of China Travel fell much faster than the general stock market, suggesting a strongly inflated price before the market crash.
16 Premium protection The holder who converts the security after a specified date and before the call protection expires can receive half of the coupon payments still remaining. Provides protection for the initial conversion premium paid at issuance. Most likely to be used by relatively small companies that need to offer investors additional incentive to provide capital.
17 CrEDITS structure (Credit Enhanced Debt Indexed To Stock) Characteristic Principal and coupon payments are guaranteed by an irrevocable letter of credit from a highly rated financial institution. Issuer s perspective Pay a lower coupon rate. Get the credit guarantee by paying amount less than the coupon rate differential. - Six percent coupon rate is reduced to four percent but with principal and income guaranteed by a high-rated third party. This works well if the protection requires less than the 2 percent coupon rate differential.
18 Attraction to investors CrEDITS structure (cont d) Upside potential of an emerging market or growth stock; A name with high stock volatility; High-quality downside protection that is uncorrelated to the shares. Example Indian Petrochemicals Corporation and GVC (a Taiwanese technology company)
19 Reset feature in convertible bonds In most cases, the reset on conversion price is downward and this makes the bond more valuable. Say, the bond becomes convertible to par worth of stock upon reset. - floor limit: the extent of downward reset cannot be below a certain multiplier of the first conversion price.
20 Examples of reset convertibles United Artists Communications (1987) issued convertibles that after a fixed period of time, the bonds were evaluated by an independent investment banker. This is to determine the coupon rate that would allow the bonds to trade at 101 plus accrued interest. Mitsuibishi Bank issued (Oct., 1995) $2 billion of 7-year bond with annual reset of the conversion ratio. It offers investors more shares if the stock price declines, with the goal of keeping the bond s equity value at par.
21 Why the reset convertible bonds are popular in Japan in mid-1990 s? Japanese banks were considered quite risky as they had large real estates exposures. To raise capital equity issuance was out of the question since the stock markets were depressed; straight bond issues would have required a high coupon yield. Reset feature was included in convertible bonds to give investors some sort of insurance against bank s stock decline.
22 Pricing difficulties There are many possible conversion prices since they depend on the past history of the stock price. Impact on bond price At high stock (not likely to reset) or low stock price (low equity value) regions, the reset premium is low. The reset premium is significant only at intermediate stock price level.
23 Delta hedge ratios For non-reset convertibles, the delta declines as the stock price drops. This is because the bond moves into the bond equivalent region, and becomes less sensitive to stock price changes. For reset convertibles, the Delta increases as the stock price declines below a certain threshold value. - The trader has to hold more shares for hedging.
24 Gamma ratios Trader should avoid negative Gamma like plague. This is because when the instrument is hedged (delta neutral), the trader loses whichever way the underlying moves. The reset convertible has negative gamma: - when the stock price drops, the investors are compensated; - when the stock price rises, the conversion premium becomes more expensive.
25 Source: Reassessing the reset, by I. Nelken, Asia Risk (October, 1998) p
26 Source: Reassessing the reset, by I. Nelken, Asia Risk (October, 1998) p
27 Source: Reassessing the reset, by I. Nelken, Asia Risk (October, 1998) p
28 Takeover clauses An unexpected takeover bid can have the effect of eliminating any conversion premium if the takeover price were below the conversion price. Poison put is added as protection in the change-ofcontrol clause: triggered as a result of a hostile takeover and would allow the bondholder to put the bonds back the company at par. to
29 Capture of accrued interest upon conversion Upon conversion to stock, any accrued interest will be lost. Trick - sell an equivalent amount of stock short against the convertible bond, hold the short sale until the interest payment date; then convert the bond and deliver the stock against the short sale.
CHAPTER 20: OPTIONS MARKETS: INTRODUCTION PROBLEM SETS 1. Options provide numerous opportunities to modify the risk profile of a portfolio. The simplest example of an option strategy that increases risk
Introduction to Convertible Debentures Intro to Convertible Debentures March, 2009 Convertible debentures are hybrid securities which offer advantages of both bonds and equities. Like ordinary bonds they
An Introduction to the Asset Class Convertible DESCRIPTION Convertible (CBs) are fixed income instruments that can be converted into a fixed number of shares of the issuer at the option of the investor.
The Stock Exchange of Hong Kong Limited takes no responsibility for the contents of this announcement, makes no representation as to its accuracy or completeness and expressly disclaims any liability whatsoever
CHAPTER 20 Hybrid Financing: Preferred Stock, Warrants, and Convertibles 1 Topics in Chapter Types of hybrid securities Preferred stock Warrants Convertibles Features and risk Cost of capital to issuers
Convertible Arbitrage Strategy The convertible arbitrage strategy has produced attractive returns over the past 15 years, which are uncorrelated with traditional equity and bond returns. What is Convertible
EQUITY LINKED NOTES: An Introduction to Principal Guaranteed Structures Abukar M Ali October 2002 Introduction In this article we provide a succinct description of a commonly used investment instrument
Glossary: The ETF Portfolio Challenge Glossary is designed to help familiarize our participants with concepts and terminology closely associated with Exchange- Traded Products. For more educational offerings,
FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin-534/fin-534-week-4-quiz-3- str/ For more course tutorials visit www.tutorialoutlet.com Which of the following
S&P Dow Jones Indices Fixed Income Policies & Practices April 2014 S&P Dow Jones Indices: Index Methodology Table of Contents Introduction 4 Calls 5 Terminology 5 Calls and S&P Dow Jones Indices 8 Calls
Tax rules for bond investors Understand the treatment of different bonds Paying taxes is an inevitable part of investing for most bondholders, and understanding the tax rules, and procedures can be difficult
American Options and Callable Bonds American Options Valuing an American Call on a Coupon Bond Valuing a Callable Bond Concepts and Buzzwords Interest Rate Sensitivity of a Callable Bond exercise policy
BOND ALERT July 2013 What Investors Should Know This special report will help you understand the current environment for bonds and discuss how that environment may change with rising interest rates. We
LDintelligence Market Neutral Convertible Bond Arbitrage Fixed Income Hedge Strategy MARKET NEUTRAL CONVERTIBLE BOND ARBITRAGE Written by: Calamos Investments This paper is a briefing on LDintelligence
CHAPTER 10 Reporting and Analyzing Liabilities Accounting for Notes Payable Obligations in the form of written notes are recorded as notes payable. Notes payable usually require the borrower to pay interest
Chapter 6 Interest Rates And Bond Valuation Learning Goals 1. Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. 2. Review the legal aspects of bond financing
UVA -F-1412 PIPEs: Private Equity Investments in Distressed Firms Direct investment in the equity of distressed companies by private equity investors is a relatively recent phenomenon dating to the mid-1990s.
Bonds are a debt instrument, where the bond holder pays the issuer an initial sum of money known as the purchase price. In turn, the issuer pays the holder coupon payments (annuity), and a final sum (face
Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual
January 2015» White paper Holding the middle ground with convertible securities Eric N. Harthun, CFA Portfolio Manager Robert L. Salvin Portfolio Manager Key takeaways Convertible securities are an often-overlooked
What are convertible debentures? CONVERTIBLE DEBENTURES A PRIMER They are hybrid securities, combining the features of a conventional debenture with the option of converting, under certain circumstances,
Review for Exam 1 Instructions: Please read carefully The exam will have 21 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation
Extra Practice Problems Instructions: The problems are similar to the ones on your previous problem sets. All interest rates and rates of inflation given in the problems are annualized (i.e., stated as
FOR RELEASE: September 2, 2004 Notice Concerning Issuance of Euro Yen Convertible Bonds due 2011 (convertible bonds type - bonds with stock acquisition rights, tenkanshasaigata shinkabu yoyakuken-tsuki
General Forex Glossary A ADR American Depository Receipt Arbitrage The simultaneous buying and selling of a security at two different prices in two different markets, with the aim of creating profits without
Table 1 Principal terms and conditions of the Notes Issuer... Resorts World Bhd. The Notes... Zero Coupon Convertible Notes due 2008, convertible into fully-paid ordinary of RM0.50 each of the Issuer (
Preferred Stocks - 1 Chapter 12 Preferred Stocks and Convertibles Preferred Stocks Valuing and Investing in Preferreds Convertibles Valuing and Investing in Convertibles Preferred stocks have preference
The Truth About Fixed Indexed Annuities Index annuities were first introduced in the United States nearly two decades ago. They were initially created as an alternative to mutual funds and variable annuities,
BASIC INFORMATION IN TRADING OF FINANCIAL INSTRUMENTS Index Definition: what is a financial instrument?...1 Money Market instruments...1 Bonds...2 American Depository Receipt...3 Stock...4 Investment funds...5
Fixed income investments make up a large proportion of the investment universe and can form a significant part of a diversified portfolio but investors are often much less familiar with how fixed income
Chapter 10 Fixed-Income Securities Bond: Tradable security that promises to make a pre-specified series of payments over time. Straight bond makes fixed coupon and principal payment. Bonds are traded mainly
1.1 Callable bonds A callable bond is a fixed rate bond where the issuer has the right but not the obligation to repay the face value of the security at a pre-agreed value prior to the final original maturity
The Merchant Securities FTSE 100 Hindsight II Note Our first FTSE-100 Hindsight Note is now fully subscribed; however, as a result of exceptional investor demand we are launching the FTSE- 100 Hindsight
PAPER P9 Management Accounting Financial Strategy The Examiner provides a short study guide, for all candidates revising for this paper, to some first principles of finance and financial management Based
EUROPEAN FIXED INCOME RESEARCH Analytical Research Series INTRODUCTION TO ASSET SWAPS Dominic O Kane January 2000 Lehman Brothers International (Europe) Pub Code 403 Summary An asset swap is a synthetic
FIN 302 Class Notes Chapter 5: Valuing Bonds What is a bond? A long-term debt instrument A contract where a borrower agrees to make interest and principal payments on specific dates Corporate Bond Quotations
Risk Control and Equity Upside: The Merits of Convertible Bonds for an Insurance Portfolio In a survey of insurance company Chief Investment Officers conducted by Eager, Davis & Holmes 1 in May 2009, 43%
The Stock Exchange of Hong Kong Limited takes no responsibility for the contents of this announcement, makes no representation as to its accuracy or completeness and expressly disclaims any liability whatsoever
91. A high yield bond fund states that through active management, the fund s return has outperformed an index of Treasury securities by 4% on average over the past five years. As a performance benchmark
Mutual Fund Investing Exam Study Guide This document contains the questions that will be included in the final exam, in the order that they will be asked. When you have studied the course materials, reviewed
Risks of Investments explained Member of the London Stock Exchange .Introduction Killik & Co is committed to developing a clear and shared understanding of risk with its clients. The categories of risk
Accounting for Bonds and Long-Term Notes Bond Premiums and Discounts Effective interest method Bond issuance Interest expense Types of Debt Instruments Zero-Coupon Bonds Convertible Bonds Detachable Warrants
Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 9-1 a. A bond is a promissory note issued by a business or a governmental unit. Treasury bonds, sometimes referred to as
A guide to investing in hybrid securities Before you make an investment decision, it is important to review your financial situation, investment objectives, risk tolerance, time horizon, diversification
Value of Equity and Per Share Value when there are options and warrants outstanding Aswath Damodaran 1 Equity Value and Per Share Value: A Test Assume that you have done an equity valuation of Microsoft.
White Paper: NPH Fixed Income Research Update Authored By: Bob Downing, CFA NPH Senior Investment & Due Diligence Analyst National Planning Holdings, Inc. Due Diligence Department National Planning Holdings,
Math 418B Worksheet 3 Callable Bonds ame: Show critical work and then circle the answer you get. In everyday business and financial usage there are three different yield associated with a bond: 1. ominal
Option Values Option Valuation Intrinsic value profit that could be made if the option was immediately exercised Call: stock price exercise price : S T X i i k i X S Put: exercise price stock price : X
Prof. Alex Shapiro Lecture Notes 15 Options: Valuation and (No) Arbitrage I. Readings and Suggested Practice Problems II. Introduction: Objectives and Notation III. No Arbitrage Pricing Bound IV. The Binomial
Contingent Convertible Debt and Capital Structure Decisions Boris Albul, Dwight Jaffee, Alexei Tchistyi CCBs are gaining attention from both, regulators and market participants Contingent Convertible Bond
PRODUCT KEY FACTS ASSET MANAGEMENT Guotai Junan Investment Funds Guotai Junan Equity Income Fund (the Sub-Fund ) January 2015 This statement provides you with key information about this product. This statement
What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? HOCK international - 2004 1 HOCK international - 2004 2 How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated? HOCK
CHAPTER 11 Solutions STOCKHOLDERS EQUITY Chapter 11, SE 1. 1. c 4. 2. a 5. 3. b 6. d e a Chapter 11, SE 2. 1. Advantage 4. 2. Disadvantage 5. 3. Advantage 6. Advantage Disadvantage Advantage Chapter 11,
Investment Strategy Should Preferred Shares Get Top Billing In Your Portfolio? When boosting the income potential of your investments, consider what preferred shares have to offer. With features that combine
Savings and Investing Consumers can use any money left over from purchasing goods and services toward savings or investing. Saving means putting money aside for future use. Investing is using savings to
REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including
Condensed Interim Consolidated Financial Statements (Unaudited) (in thousands of United States dollars) Condensed Interim Consolidated Statements of Financial Position (in thousands of United States dollars)
1. What are convertible bonds? Convertible bonds, most importantly, are bonds. They carry all the same promise of repayment of principal and interest of all corporate bonds. Unlike other bonds, though,
SS15 Fixed-Income: Basic Concepts SS15 Fixed-Income: Analysis of Risk SS 15 R52 FI Securities: Defining Elements R53 FI Markets: Issuance, Trading, and Funding R54 Introduction to FI Valuation SS 16 R55
Answers to Concepts in Review 1. Bonds are appealing to investors because they provide a generous amount of current income and they can often generate large capital gains. These two sources of income together
Risk & Return Fixed Income Arbitrage: Nickels in Front of a Steamroller by Jefferson Duarte Francis A. Longstaff Fan Yu Fixed Income Arbitrage Broad set of market-neutral strategies intended to exploit
WHITE PAPER CONVERTIBLE BONDS THE BEST OF BOTH WORLDS Convertible bonds have become an increasingly popular asset class in recent years, as issuers and investors have gained an improved understanding of
About Hedge Funds What is a Hedge Fund? A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost
ILLUSTRATION 17-1 CONVERTIBLE SECURITIES CONVERTIBLE BONDS Issued ten, 8%, $1,000 par value bonds at 110. Each bond is convertible into 100 shares of $5 par value common. Entry at date of issue: Cash 11,000
CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support
Banking,, Banking,, for the MFM Orientation September 1, 2010 Banking,, If you are going to work with bankers, traders, or investment managers, it is important for you to understand the language and concepts
A Modeling Exchangeable Bonds WHITE PAPER MONIS CONVERTIBLE BONDS MODELING EXCHANGEABLE BONDS Contents 1 Introduction 1 Setting up an exchangeable bond 3 Conclusion 4 Appendix Modeling Exchangeable Bonds
GUIDE TO INVESTING IN MARKET LINKED CERTIFICATES OF DEPOSIT What you should know before you buy What are Market Linked CDs? are a particular type of structured investment issued by third-party banks. A
What is Equity Linked Note Equity Linked Note (ELN) is a yield enhancement instrument which relates to equities & provides investors with the opportunity to attain superior yield over money market instruments.
INFORMATION TO CLIENTS REGARDING THE CHARACTERISTICS OF, AND RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS (SHARES, SHARE-RELATED INSTRUMENTS AND BONDS) The client fully understands: that investments are
A ADR-Style: for a derivative on an underlying denominated in one currency, where the derivative is denominated in a different currency, payments are exchanged using a floating foreign-exchange rate. The
ECON 4110: Sample Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Economists define risk as A) the difference between the return on common
Absolute return: The search for positive returns in changing markets Tuesday, 7 June 2011 Portfolio Manager for Global Fixed Income and Absolute Return Funds www.dbadvisors.com Topics for discussion What
Patrick McCluskey, Senior Fixed Income Strategist Fixed Income Strategy May 23, 2016 A Guide to Investing in Community Bank Preferred Stock What is Preferred Stock? Preferred stock is a perpetual fixed-income
Senior Secured Loans An Alternative Way to Diversify an Income Strategy Alternative Thinking Series There is no shortage of uncertainty and risk facing today s investor. From high unemployment and depressed
1.2 Structured notes Structured notes are financial products that appear to be fixed income instruments, but contain embedded options and do not necessarily reflect the risk of the issuing credit. Used
AUSTRALIAN BANKS GLOBAL BOND FUNDING 1 Introduction Over the past decade, Australian banks have sourced a sizeable share of their funding in offshore markets. This article examines various aspects of these
KM Model Expected default frequency Expected default frequency (EDF) is a forward-looking measure of actual probability of default. EDF is firm specific. KM model is based on the structural approach to
CHAPTER15 Long-Term Liabilities Acct202 15-1 15-2 PreviewofCHAPTER15 Bond Basics Bonds are a form of interest-bearing notes payable. Three advantages over common stock: 1. Stockholder control is not affected.
Featured Solution May 2015 Your Global Investment Authority The Credit Analysis Process: From In-Depth Company Research to Selecting the Right Instrument In today s low yield environment, an active investment
How to calculate cash flows on index-linked gilts Index-linked gilts pay semi-annual cash flows indexed to the Retail Prices Index (RPI). In practical terms this means that both the coupons and the principal
This Product Highlights Sheet is an important document. It highlights the key terms and risks of this investment product and complements the Prospectus¹. It is important to read the Prospectus before deciding
Your consent to our cookies if you continue to use this website.