Convertible Bonds Flashcards
How can a company finance itself
Raise capital (sell shares, dilute ownership)
Issue bonds (increase debt, deteriorates capital structure)
Issue convertible bonds: the investor gets to take advantage of rising share value while being protected against a bond’s convexity
What is a bond’s convexity?
Assuming the modified duration of a bond gives us a linear function between the value of the bond in response to interest rates.
The convexity shows the non-linear relationship between a bond’s price to changes in interest rates
Basically, the convexity explain the additional drop in value of a bond due to a rise of interest rates and viceversa that is not explained thanks to the modified duration
What is a convertible bond?
It’s a bond issued by a company that can be transformed into shares
When will the bondholder exercise the option?
They will exercise the option when the conversion value of the bond > bond nominal amount K
Why do convertible bonds appeal to investors?
They are a listed, liquid, structured product that easily adapt to different behaviours
What is the conversion ratio?
The amount of shares to be redeemed if you convert the bond
What is the conversion price
Nominal/conversion ratio. It’s the price above which the bond will convert at maturity
Conversion period
period during which the holder is allowed to convert the bond (from issue to a couple days before maturity)
Parity
Conversion ratio*conversion price
Conversion premium
(Clean price-parity)/parity
What is clean/flat price
price that does not take into account the accrued interest on the bond since its last payment date.
Clean price: dirty price-accrued interest
What is accelerated bookbuilding?
Building up an order book quickly (hrs, days) with minimal promotion => useful for companies with immediate liquidity needs (e.g. acquisition)
What is bookbuilding?
Systematic process of generating, capturing and recording investor demand
for shares
What are the differences between acquiring shares via bookbuilding and trading?
Book bids are confidential, stock market bids and offers are transparent
book auction by invitation
all shares are transferred at the same price
The price is decided by the bookrunner and issuer (not the market)
What does the bookrunner do?
Collects bids (can be revides until the book closes) from investors at different prices, between the floor price and the ceiling price.
After the bookbuilding period, the bookrunner evaluates the bids collected on the
basis of certain evaluation criteria and sets the final issue price.
