Glossary of Convertible Bond Terms

144a

Indicates that the convertible security was issued under SEC rule 144a and was not registered by the SEC. 144a securities can only be purchased by Qualified Institutional Buyers (QIBs)

Accreted value

OID and premium redemption convertibles ‘accrete’ over their life from issue price to redemption price. The prospectus sometime lays down a straight line appreciation but more often one that maintains the bond on its issue redemption yield.

Accrued interest

This is the value of the accrued portion of the coupon on a convertible bond. Most Eurobonds adopt a 360 day convention.

American-style option

This type of option allows the holder to exercise into the underlying asset at any time during the life of the option.

Anti-dilution provisions

These provide for an adjustment in the conversion terms in the event of special stock dividends, stock splits or other corporate events that can result in the dilution of the underlying share price.

At-the-money

A convertible is said to be at-the-money if the current share price is close to the conversion price.

Balanced convertible

A balanced convertible is a convertible that trades at a price where it is neither a pure equity substitute nor trading on its bond floor, but is balanced between the two.

Binomial tree

A binomial tree option-pricing model estimates the theoretical value for an option. Adaptations of the approach are commonly applied to convertible bonds. They take account of events such as puts and calls that take place during the life of the instrument.

Black-Scholes option pricing model

The option pricing model derived by Fischer Black and Myron Scholes is used to estimate the theoretical fair value of European options based on a range of inputs and assumptions.

Bond floor (or investment value)

The bond floor is the value of the fixed income element of the convertible if rights of conversion are ignored.

Bond with/cum warrant

This is a straight bond issued with a long maturity call option attached. The bond and warrant can typically be traded separately in the secondary market.

Breakeven

The breakeven calculation for a convertible measures the time taken for the bond’s income advantage to offset the conversion premium. It is a simple measure that takes no account of dividend growth projections or discounting for present value.

Call feature (or call option)

A call feature gives a convertible issuer the right to redeem a convertible  bond prior to maturity at a price determined at issue. Holders of convertibles who receive a call notice will generally have time to exercise their rights of conversion before repayment takes place; thus a call option can frequently be interpreted as required early conversion. (see also ‘trigger’)

Clean price

The clean price is the price of a convertible bond quoted excluding accrued interest. Most convertibles are quoted this way.

Clean-up call

If an issuer is entitled to call any remaining bonds when a certainpercentage of the bond issue has already been converted into shares, or otherwise extinguished, it is termed a ‘clean-up call’. The percentage is often set at around 90% of the convertible issue size.

Contingent conversion

A contingent conversion feature makes a convertible investor’s ability convert contingent upon the share price attaining a specified level.

Contingent interest payment

Contingent interest payment features allow the payment of a small amount of interest to the convertible bondholder if the average market price of the convertible falls to a specified level in a specified time frame.

Conversion premium

See premium.

Conversion price

At issue, the conversion price is the price at which shares are effectively bought’ upon conversion, if the convertible is purchased at the issue price. It is calculated by dividing the issue price of the bond by the conversion ratio. It is market convention to define conversion price at maturity for a single currency bond as the principal amount divided by the conversion ratio, even for even for bond with above par redemption.

Conversion price = Par Value/Conversion ratio

Conversion ratio

The conversion ratio is the number of shares into which each bond can be converted.

Conversion ratio = Par Value/Conversion Price

Convertible preferreds

Convertibles issued in the form of preferred shares. They pay a fixed ‘dividend’, equivalent to a coupon, and are sometimes issued in perpetual form.

Convertible price

This is the price at which the convertible is traded in the market. It is generally quoted as a percentage of par.

Coupon

The coupon is the interest payment per bond. It is normally quoted as a percentage of the face value.

Credit spread

The credit spread is the spread over the swaps curve (or sometimes Government bond curve) at which the issuer is assumed able to issue a straight bond that is otherwise identical to the convertible.

Cross currency convertible

A convertible that is denominated in a different currency to that of the underlying shares.

Current (or running) yield

Current yield is the income per unit of currency invested. It is calculated by dividing the coupon by the current convertible price.

Cushion

The excess of parity over the call price that an issuer requires before issuing a call notice.

DECs

DECS stands for Dividend Enhanced Convertible Securities or Debt

Exchangeable for Common Stock. DECs are mandatory convertibles, typically issued as preferred stock paying quarterly fixed dividends.

Delta

Delta is a measure of the sensitivity of the convertible bond price to share price movements. It is defined as the expected change in the convertible price for a small absolute change in parity.

Dirty price

The dirty price is the clean price of a convertible bond plus its accrued interest. It is the actual price an investor will pay for a bond.

Dividend yield

The dividend yield is an indication of the income generated by each share. It is calculated by dividing the annual dividend per share by the share price.

European option

This type of option gives the holder the right to exercise only on the maturity date.

Exchangeable bond

This is a convertible bond issued by one company that can be converted into the shares of a different company.

Gamma

Gamma measures the sensitivity of the convertible bond’s delta to share price movements. It is the change in delta for a one-point change in parity.

Greenshoe

The greenshoe is an over-allotment option that allows an underwriter to increase the number of bonds issued, typically by 10%-15%, when there is strong demand for an initial offering.

Hard call protection

A period of time during which the issuer may not call the bond from the investor.

Denomination

This is the minimum size in which the bond can be traded

Hedge ratio

A convertible bond’s hedge ratio is also referred to as ‘delta’. The hedge ratio shows the equity sensitivity of a convertible bond and enables an investor to calculate how many shares he would need to sell to hedge the equity exposure.

Implied volatility

Implied volatility is the convertible pricing model volatility input that brings the fair value of a convertible into line with its market price.

In-the-money

A convertible is said to be in-the-money if the current share price is greater than the conversion price.

Issue price

The issue price is the price at which convertible bonds are sold to investors at issue.

Mandatory convertible

This is a convertible in which the bondholder is obliged to convert into the underlying equity.

Maturity

The maturity date is the final redemption date of the bond.

Nominal value

This is the face value of the bond. It is often 1,000 of the relevant currency in the Euroconvertible market and ¥1,000,000 in the Japanese and Euroyen markets. The current price, issue price and redemption price of most convertibles are expressed as a percentage of the nominal value.

Original issue discount (OID)

A convertible issued at a discount to par is termed an original issue discount convertible.

Out-of-the-money

A convertible is said to be out-of-the-money if the current share price is below the conversion price.

Par

Par is the face value of a bond.

Parity

Parity is the market value of the shares into which the bond may be converted. It is calculated by multiplying the conversion ratio by the current share price expressed in bond currency terms. It is normally expressed as a percentage of a bond’s nominal value.

PERCs

PERCs stands for Preferred Equity Redemption Cumulative Stock. PERCs are a mandatory convertible bond structure that caps upside participation in a stock’s performance.

Premium

A convertible’s premium is the percentage by which the market price of the convertible bond exceeds parity. It represents the extra cost an investor must pay to buy the shares a bond converts into via a convertible. It is calculated by subtracting parity from the convertible price and is expressed as a percentage of parity.

Premium redemption structure

This describes a convertible bond that is issued at par but redeems at a premium to par.

Put feature

A put gives investors the option to sell back the convertible bond to the issuer at a fixed price on a given date or dates.

Ratchet

In some convertibles there is a ratchet mechanism in which the conversion ratio is adjusted by a specified amount if a takeover takes place within a given time frame.

Parity

Parity is the market value of the shares into which the bond may be converted. It is calculated by multiplying the conversion ratio by the current share price expressed in bond currency terms. It is normally expressed as a percentage of a bond’s nominal value.

PERCs

PERCs stands for Preferred Equity Redemption Cumulative Stock. PERCs are a mandatory convertible bond structure that caps upside participation in a stock’s performance.

Premium

A convertible’s premium is the percentage by which the market price of the convertible bond exceeds parity. It represents the extra cost an investor must pay to buy the shares a bond converts into via a convertible. It is calculated by subtracting parity from the convertible price and is expressed as a percentage of parity.

Premium redemption structure

This describes a convertible bond that is issued at par but redeems at a premium to par.

Put feature

A put gives investors the option to sell back the convertible bond to the issuer at a fixed price on a given date or dates.

Ratchet

In some convertibles there is a ratchet mechanism in which the conversion ratio is adjusted by a specified amount if a takeover takes place within a given time frame.

Reset date

The date on which a change of conversion terms takes place on a reset convertible is termed the reset date.

Reset features

Reset features allow for a change in the conversion price of a convertible in the event of share price depreciation (downward reset) or appreciation (upward reset) on certain specified dates.

Reset floor

The limit below which the conversion price on a reset convertible cannot fall.

Reset period

In most reset convertibles, the share price upon which the new conversion price is based is calculated by reference to the average share price observed in a specified reset period.

Rho

Rho measures the sensitivity of the convertible price to movements in interest rates. It is expressed as the change in the convertible price for a one basis point move in interest rates (a parallel shift in the yield curve).

Risk premium

The risk premium is the difference between the convertible price and the bond floor expressed as a percentage of the bond floor.

Soft call (or provisional call)

This is a period of time during which the issuer may only call the bond if the share price has traded above a predetermined level for a set period of time.

Step-up coupon

This is where the coupon level increases at a future date. This can be a contingent event on for instance, a credit rating downgrade.

Theta

Theta is the change in the convertible value with the passage of time. It is expressed as the change in the convertible price for the passing of on day, other things being equal.

Trigger

The threshold above which a share must trade before the issuer can dispatch a call notice. It is normally expressed as a percentage of the conversion price. Thus a 130% trigger means the share price must trade, for a specified period, at 130% of the conversion price. With dual currency convertibles the trigger is sometimes expressed in relation to the share price expressed in domestic currency terms and sometimes in the currency of the bond.

Vega

Vega is the sensitivity of the convertible price to changes in the volatility of the underlying stock. Vega is the change in the fair value of the convertible for a one percentage point change in the assumption for stock volatility.

Volatility

Share price volatility is a measure of the dispersion of share price returns. It is defined as the annualised standard deviation of returns. The extent to which the underlying share price has fluctuated over a certain period determines the historical or observed volatility. The assumption for future share price volatility is an input for convertible valuation.

Yield advantage

The yield advantage is the difference between the current yield on the convertible bond and the stock dividend yield.

Yield to maturity

Yield to maturity (YTM) is the discount rate that equates the current market price of a straight bond to the present value of its future cash flows.