Convertible Bonds: Issuing, Pricing and Investing

Day One

Introduction and Course Outline

The convertible bond market

• Trading Strategies
• Market Players
• Cheapness
• Yield Measures
• Liquidity

Convertibles Primer

Basic introduction to what a convertible bond is and what its key elements are. Attention is given to the nomenclature: Convertible bonds come with their own language and conventions which are different from the traditional derivatives language: conversion premium, parity, conversion price, etc.

Convertible bonds: Instrument Features

• Issuer Calls
• Investor Puts
• Cross Currency Convertible Bonds
• Resets
  • A deeper understanding will be provided regarding the reset feature. The negative convexity of this feature can be a real trap for the convertible bond arbitrageur.
• Dividend Protection

From prospectus to model

This part of the course is exercise driven.  Based on several real-world prospectuses, the delegates will set-up a convertible bond from scratch dealing with the different instrument specific features: issuer calls, investor puts, etc. Starting from these sample prospectuses, the participant in the course will have to set up a valuation and initial hedge for each of these real-world examples.

This will be done by making use of interactive spread sheet-based models. All of the knowledge build up in the previous session is going to be embedded in this workshop. 

Pricing Models

This part of the course introduces the delegates to the different mainstream models to value convertible bonds.

• Equity Models:
  • Black-Scholes
  • Jump-Diffusion
  • Heston
• Credit Models:
  • Blended Credit Spread
  • Intensity based (CDS based models)

Risk Management and hedging of a convertible bond portfolio

• Delta hedging
  • Starting from a real world example, the delta hedging of a convertible bond portfolio will be explained. It will be shown how any delta hedge changes the risk profile of the bond
• Gamma trading
  • This section will deal with the impact of a frequent rebalancing of the hedge in low and high volatile markets
• Credit and Volatility hedges
  • This section will examine with the way to use listed options to deal with some of the volatility risk embedded within a convertible bond. Volatility contracts such as VIX and their possible pitfalls will be explained as well
• Sensitivity Analysis
  • This is an introduction to the different risk measures that can be applied to convertibles

Convertible Bond: Advanced Instrument Features

• Ratchets

Extended example on how ratchets should be evaluated whenever the convertible gets involved in a takeover situation

• Convertible Bond Options (ASCOTS)

Hedging the credit risk by making used of options on convertible bonds.

Day Two

CoCos and Hybrids – part I

Introduction to Hybrid Assets

• Issuers
• Rating Agencies
• Performance
• Particular Risks : Regulatory calls, rating calls an extension risk

Preferreds : equity or bond volatility?

Corporate Hybrids

• Yield pick-up
• Coupons : cancellation risk
• Replacement Capital Covenant
• Rating Agencies
• Extension Risk : introduction

Contingent Capital

• Definition
• Timeline
• Anatomy
• CoCos with upside
• CoCos vs convertible bonds
• Tier 1 and Tier 2 CoCos
• Pro and Contra
• Alternative structures

Bail-In Capital

• Definition and differences with CoCo bonds
• Examples of bail-in
• Resolution Framework in  Europe

Day Three

CoCos and Hybrids – part II

Regulatory Framework

• Basel III
• ECB’ Stress Tests and CoCos
• CRD IV

Risk profile of CoCo Bonds

• Sensitivity-analysis
• Death Spiral
• Extension Risk

Pricing Models

• Equity Derivatives Approach
• Credit Derivatives Approach
• Adding Extension risk

Case Study: setting up a CoCo bond from scratch