Convertible Bonds

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Convertible bond

PRESENTED BY ,
G.Harshini
Janupriya
S.Anukarthika
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Convertible bond
A convertible bond or convertible note

or convertible debt is a type of bond that
the holder can convert into a specified
number of shares of common stock in the
issuing company or cash of equal value.

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Call provisions
Call provisions
Convertible valuation as a stock plus method
Think stock with higher yield

Conversion value=stock price * conversion factor
Zero coupon bonds with options
Valuation of zero coupon bonds
Mandatory convertible
High dividend yield and a cap
EXAMPLE: PERCS, DECS

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Put options to hedge the credit risk of CBs-

bearish hedge
High loss when the stock price moves up

sharply
Convertible asset swap
Synthetically separates the fixed income

component and equity
Repurchase facility
Trader to a broker – broker to a bond buyer
Bond buyer floating rate and broker has the
fixed rate
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Convertible bond CDS
Manage the credit risk of CBs
Transferring the credit risk to the swap

seller for specified time period
Is like a insurance policy against specified
issue
Put option

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Why CB may be called back by the
issuer?
Refinance at lower rate or deep in the

money
Most companies force conversion
What happens if parity falls below the call
price?

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Convertible Bonds
A derivative product
Standard Corporate bond with an option
Sensitive to interest rate & volatility of

underlying equity
Worth of CB
- At the minimum of non- convertible bonds
- Coupon on CB is higher than dividend on
shares

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Why to Issue CB?
Reduce dilution
To lower the coupon rate on debt
Raises the price of share, sold at premium to

current price

• Why investors need to buy CB?
Lowers risk
Higher yield than share dividend
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Conversion ratio & Conversion price
Conversion Ratio- No of shares that each
bond
can be converted
Eg: If the conversion price is $100
Then, Conversion Ratio = Par value of the
bond/
Conversion Price
= 1000/100 = 10
CR & CP- can be changed (Stock splits &
stock dividends)
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Conversion parity
Relationship between (stock price *conversion factor)

and bond price
If Bond price = $1200, CR = 10 , Share price= $120
-> at parity
If Bond price = $1200, CR = 10 , Share price= $100

-> below parity
If Bond price = $1200, CR = 10 , Share price= $130

-> above parity
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Conversion Premium
Usually CBs are bought at higher price than

conversion value

Eg: Conversion Premium = 1200-(10*100) =
$200
Premium paid- to limit the downside risk of CB
Investors usually – Buy CBs and short

underlying asset
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Types of CB
Callable CB
 Allows the issuer to buy back the bond

Puttable CB
 Investor can sell to issuer; put option raises the

value of CB
Resettable CB
 Conversion ratio can be reset based on average

price of underlying asset

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