Convertible bonds Bond instruments with equity-linked features
Bond instruments with equity-linked features
Convertible bonds as an asset class o Equity and fixed income perspectives o Convexity ratio o Embedded features Investors conversion right -equity participation Issuer's call right: delayed equity financing Investors put rig principal and coupons protection o Busted convertibles seeking Investment opportunities in recovery period Convertible bonds
Slide: 2 Equity and fixed income perspectives Convexity ratio Embedded features - Investor’s conversion right – equity participation - Issuer’s call right: delayed equity financing - Investor’s put right – principal and coupons protection Busted convertibles - seeking investment opportunities in recovery period Convertible bonds
o 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 o Fixed income perspective on convertibles Provides the bond floor?" value Conversion option that allows the investor to exchange the bond for fixed number of shares Convertible bonds
Slide: 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. • Conversion option that allows the investor to exchange the bond for fixed number of shares. Convertible bonds
Combination of bonds and equities bond plus a conversion option Bondholder has the right to convert the bond into common shares at some contractual price (conversion number may change over time) Holder's perspective: take advantage of the future potential growth of issuer s company Issuer's perspective: raise capital at a lower cost by the provision of conversion privilege to bondholders Convertible bonds
Slide: 4 Bondholder has the right to convert the bond into common shares at some contractual price (conversion number may change over time). Holder’s perspective: take advantage of the future potential growth of issuer’s company Issuer’s perspective: raise capital at a lower cost by the provision of conversion privilege to bondholders Convertible bonds
Combination of bonds and equities bond plus a conversion option convertible bond price conversion premium conversion value straight bond value cock pric Convertible bonds
Slide: 5 convertible bond price conversion premium conversion value straight bond value stock price Convertible bonds
Convexity ratio o Classic"two-thirds upside, one-third downside o Convexity ratio is the ratio of upside and downside participation For example, suppose the convertible provides 64% of the upside participation with only 34% of the downside movement then the convexity ratio is 1. 85. That is, the convertible provides 85%o more upside participation than downside risk Convertible bonds
Slide: 6 Classic “two-thirds upside, one-third downside” Convexity ratio is the ratio of upside and downside participation. For example, suppose the convertible provides 64% of the upside participation with only 34% of the downside movement, then the convexity ratio is 1.85. That is, the convertible provides 85% more upside participation than downside risk. Convertible bonds
Insulation from volatility The price movements of convertibles are generally far less volatile Convertible Bond Price Changes August 24, 2001-September 21, 2001 Common Stock Convertible Closing Price Closing Price % Closing Price Closing Pi C 24820012192001 Change24820021200che Avon Products 44.04 4.03 51.13 51.25 0.24 Bell atlantic/ 17.85 14.15 20.73 100.50 101.25 0.75 New Zealand Tel Diamond Offshore 2790 2635 84.13 0.75 Federal Realty Trust 23.62 -13.97 93.2 87.13 -6.57 INCO 1755 12.45 -2906 9938 97.25 2.14 Average -14.15 2.78 DJIA 10423.208235.81 -20.99 20.99 S&P500 1184.90 96580 18.49 -18.49 NASDAQ 1916.80 1423.19 25.75 -25.75 Convertible bonds
Slide: 7 The price movements of convertibles are generally far less volatile. Closing Price Closing Price % Closing Price Closing Price % Company 24/8/2001 21/9/2001 Change 24/8/2001 21/9/2001 Change Avon Products 45.89 44.04 4.03 51.13 51.25 0.24 Bell Atlandtic/ New Zealand Tel 17.85 14.15 -20.73 100.50 101.25 0.75 Diamond Offshare 27.90 26.35 -5.56 83.50 84.13 0.75 Federal Realty Trust 23.62 20.32 -13.97 93.25 87.13 -6.57 INCO 17.55 12.45 -29.06 99.38 97.25 -2.14 Average -14.15 -2.78 DJIA 10423.20 8235.81 -20.99 -20.99 S& P 500 1184.90 965.80 -18.49 -18.49 NASDAQ 1916.80 1423.19 -25.75 -25.75 Common Stock Convertible Convertible Bond Price Changes, August 24, 2001-September 21, 2001 Convertible bonds
Call features Convertible bonds
Slide: 8 Call features Convertible bonds
Call terms o 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 Convertible bonds
Slide: 9 Issuer has the right to call back the bond at a prespecified 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. Convertible bonds
Issuer's perspective on the call right o To have the flexibility to call if they think they can refinance the debt more cheaply o 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. In summary, it is used as a tool by issuer for possible future equity financing managing the debt /equity balance Convertible bonds
Slide: 10 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. In summary, it is used as a tool by issuer for possible future equity financing – managing the debt / equity balance. Convertible bonds
