Debt and structured finance, including bonds and convertible instruments
Debt and structured finance, including bonds and convertible instruments
This domain tests the debt products a corporate finance adviser meets in practice, the listing routes for debt, and the analytics of convertible and exchangeable instruments.
Products and listing routes
- Plain vanilla bonds, medium term note programmes, high-yield notes, perpetual securities, convertible bonds, exchangeable bonds and bonds with warrants.
- Chapter 22: debt issues to the public; prospectus requirements and SFC authorisation apply.
- Chapter 37: debt issues offered only to professional investors; lighter disclosure, but restrictions on onward transfer to the public.
- A professional investor under Schedule 1 of the SFO includes an individual with a securities portfolio of at least HK$8 million and a corporation or partnership with total assets of at least HK$40 million (or a portfolio of HK$8 million).
Convertible analytics
- Conversion ratio = face value ÷ conversion price.
- Conversion value (parity) = conversion ratio × current share price.
- Conversion premium = (conversion price ÷ share price) − 1.
- The bond floor is the present value of coupon and redemption cash flows discounted at a credit-adjusted yield; in theory the convertible should not trade below it.
- The equity option component is valued with Black-Scholes using share price, conversion price, volatility, time to maturity, dividend yield and the risk-free rate.
- Exchangeable bonds convert into shares of a company other than the issuer, typically a subsidiary or an associate.
Worked example
A convertible bond with a face value of HK$1,000 has a conversion price of HK$10, so the conversion ratio is 100 shares. If the share price is HK$8, conversion value is HK$800 and the conversion premium is (10 ÷ 8) − 1 = 25%. An investor buying at par pays HK$1,000 for HK$800 of equity value; the remaining HK$200 reflects time value and downside protection, which is what the bond floor and the option component measure.
Traps
- Confusing conversion premium with conversion value.
- Forgetting that a conversion price reset, bonus issue or dividend adjustment changes the ratio.
- Treating a perpetual as equity for all regulatory purposes; accounting and rating treatment can differ.
- Assuming Chapter 37 debt sold to professional investors can later be freely offered to the retail public.
- Quoting the wrong professional investor thresholds (HK$8 million portfolio; HK$40 million total assets for corporations).