Callable Convertible Bonds Research Articles

The origin of LYONs: A case study in financial innovation

The origin of LYONs: A case study in financial innovation

Why do firms issue callable convertible bonds? A critique of the “backdoor equity financing” theory

We revisit Stein (1992)’s model and demonstrate that it provides an insufficient justification for the use of callable convertible bonds as financing instruments. A standard convertible bond solves the firm’s financing problem in both the simple and extended versions of the model. More generally, convertibles have little relevance within this model because the firm can finance efficiently with a package of equity and short-term straight debt, the components of which are dynamically adjusted. This package becomes a superior financing strategy in comparison to convertible debt if one relaxes the model’s assumption that the firm can always force conversion.

The Effect of Corporate Ownership Structure on Firm’s Financing: An Analysis of the Issuance of Callable Convertible Bonds

[연구목적] 콜옵션부 전환사채는 재무상황이 어려운 기업이 지배구조의 안정성을 유지하면서 자금을 조달할 수 있는 순기능에도 불구하고 지배주주의 지분확보를 위한 수단으로 이용될 수 있다는 문제점이 제기되고 있다. 기업이 콜옵션이 부여된 전환사채를 사모로 발행하면서 전환사채의 투자자에게 기업이 지정하는 특정인에게 전환권을 되팔도록 하거나, 기업이 콜옵션을 행사하여 전환권을 인수한 다음 특정인에게 매도하면 전환권 인수자는 유리한 조건으로 지분을 확보할 수 있다는 것이다. 본 연구는 발행하는 전환사채의 구조에 따라 지배주주의 영향력에 차이가 있는지를 확인하기 위하여 지배주주지분율과 일반 전환사채와 콜옵션부 전환사채 발행의 관계를 분석하였다. [연구방법] 분석대상은 유가증권 시장과 코스닥 시장에 상장된 12월 결산 비금융기업 중 2014년부터 2019년까지 전환사채를 발행한 기업이다. 발행된 전환사채를 일반 전환사채와 콜옵션부 전환사채로 구분하고, 콜옵션부 전환사채의 콜옵션율이 지배주주지분율보다 큰 경우와 지배주주가 최고경영자(CEO)인 경우로 구분하여 회귀분석을 실시하였다. [연구결과] 지배주주지분율은 일반 전환사채 발행에 대해서는 음(-)의 관계이나, 콜옵션부 전환사채 발행에 대해서는 양(+)의 관계임을 발견하였다. 지배주주와 최고경영자(CEO)가 동일인인 기업과 발행하는 전환사채의 콜옵션율이 지배주주지분율보다 더 높은 기업에서 콜옵션부 전환사채 발행에 더 적극적임을 확인하였다. 그러나 같은 콜옵션부 전환사채라 하더라도 제3자에게 콜옵션 행사권리가 부여되지 않은 콜옵션부 전환사채 발행에 대해서는 음(-)의 관계를 나타냈다. [연구의 시사점] 본 연구는 콜옵션부 전환사채 발행과 지배주주지분율의 관계에 대한 최초의 실증분석을 실시하여 콜옵션부 전환사채가 지배주주의 지분확보를 위해 이용되고 있음을 실증적으로 분석했다는 점에 중요한 의의가 있다.

Pricing Convertible Bond in Uncertain Financial Market

This paper is devoted to evaluating the convertible bonds within the framework of uncertainty theory. Under the assumption that the underlying stock price follows an uncertain differential equation driven by Liu process, the price formulas of convertible bonds and the callable convertible bonds are derived by using the method of uncertain calculus. Finally, two numerical examples are discussed.

What is Wrong with Convertible Bonds that Provide Call Options to Third Parties?

Callable convertible bonds (CBs) that provide call options to third parties but are not used in major economies have been issued since issuances of detachable privately placed bonds with warrants (BWs) were banned in 2013. The largest shareholders prefer callable CBs to detachable BWs as they are purchased only if call options are in the money. This study analyses the effect of call options on the announcement effects of CB issuances and conversion right exercises using 1,496 privately placed CBs issued between 2013 and 2018. The major findings are as follows. First, the announcement effects of callable CBs are significantly smaller than those of standard CBs, which indicates that providing call options to third parties is viewed negatively. Second, callable CB issuing firms have better operating performance, higher ownership of the largest shareholders, and a higher adoption rate of refixing clauses than standard CB issuing firms. Third, the announcement effects of exercising conversion rights are significantly negative and those of callable CBs are significantly more negative than those of standard CBs. In summary, the results highlight the structural problems of callable CBs and provide empirical evidence to support our hypothesis. We recommend that financial authorities ban the issuance of callable CBs.

The fluctuating maturities of convertible bonds

The maturities of newly issued convertible bonds vary substantially over time. Firm-specific determinants of maturity from the straight debt literature are relevant for convertible bonds. However, the growth of the convertible arbitrage industry and the role of convertible arbitrage hedge funds have changed the importance of firm characteristics in the convertible bond market. Recently issued convertible bonds come with particularly short maturities that serve as substitutes for call provisions. This substitution implies that backdoor-equity and sequential-financing rationales for issuing callable convertible bonds are also applicable for non-callable convertibles with shorter maturities.

Callable convertible bonds in sequential financing: Evidence on the Western European market

The objective of the paper is to test empirically the Mayers (1998) sequential financing hypothesis stating that companies issue callable convertible debt to overcome the problem of overinvestment (Jensen, 1986) that could arise in a sequential investment setting. As a result of this theory we should observe higher investment and financing activities at the exercise call dates especially if it is in the money. Based on a sample of 277 Callable Convertible Bonds issued by non-financial firms in Western Europe between 1994 and 2009, comprising 161 callable convertible bonds being subject to forced conversion (calling subsample) and 116 non-called convertible bonds (non-calling subsample) and using classical and difference-in-differences methodologies, we find evidence only weakly in line with the sequential financing hypothesis of Mayers (1998). For the calling firms, we, in general, do not observe significant positive changes in capital expenditure at call dates that are greater than those of the non-calling firms. We observe a significant difference in new equity issuances only for the comparison between calling and non-calling firms. Unlike Alderson et al. (2006), we find that in the money calling firms increase their investment around the convertible bonds calls more than out of the money calling firms. We also find a positive impact of the call decision on the change of the new debt issuance at the call dates.

Valuing Convertible Bonds: A New Approach

A recent paper by Finnerty expresses the value of a convertible bond as the value of the straight bond component plus the value of the option to exchange the bond component for a specified number of conversion shares and develops a closed-form convertible bond valuation model. This article illustrates how to apply the model to value nonredeemable convertible bonds and callable convertible bonds. The article also compares model and market prices for a sample of 148 corporate convertible bonds issued between 2006 and 2010. The average median and mean pricing errors are −0.18% and 0.21%, respectively, which are within the average bid-ask spread for convertible bonds during the postcrisis sample period.

Valuation of convertible bond under uncertain mean-reverting stock model

Different from the classical method of pricing convertible bond under stochastic stock model, we investigate the valuation of convertible bond under uncertain mean-reverting stock model which is described by an uncertain differential equation. Within the framework of uncertainty theory, we proposed the uncertain pricing method, and present the price formulas of the convertible bond and the callable convertible bond.

Przesłanki emisji obligacji zamiennych z opcją call przez spółki amerykańskie i europejskie – analiza porównawcza

The aim of the article is to identify the reasons for using the call option in convertible debt financing and to find out whether these motives differ across countries. The analysis encompasses 299 issues of callable convertible bonds carried out by American and European companies from the service and manufacturing sector between 2004 and 2014. It turns out that both American and European firms are likely to use the call provision in order to avoid redeeming debt at maturity by either ensuring them a right to repay nominal value of bonds before maturity (American firms) or by forcing an early conversion on bondholders (European firms). Moreover, it seems that companies use callable hybrid debt to raise capital for financing new investment projects which may help them to increase their financial results.

Decomposing and valuing convertible bonds: A new method based on exotic options

We use exotic options to develop a complete decomposition method for analyzing callable convertible bonds (CCBs), and puttable callable convertible bonds (PCCBs) with credit risk. Since exotic options are path-dependent while vanilla options are not, exotic options can better address the risk exposure, and better replicate the payoff features of CCBs and PCCBs embedded with path-dependent options, than do vanilla options or warrants used by previous decomposition methods. Our method provides investors with an effective tool to analyze the effects and interactions of the different provisions contained in CCBs and PCCBs. This provides better insight into the valuation and analysis of CCBs and PCCBs.

Callable Convertible Bond Valuation Framework and VIC Case

Convertible bond, a hybrid instrument that offers the holders both fixed income of straight debt and capital gain of equity via attachment of the right to convert to common shares of issuing companies, has recently been issued in mass by important Vietnamese banks and groups. To account for this growing trend, this paper aims to help market participants to gain more insight on the products as well as the possible methods of pricing. The authors first describe the characteristics and risks of convertible bond in general and callable convertible bond in particular. Secondly, due to the fact that Vietnam convertible market is very much it its early stage, analytical tools are vital to assist participants in the estimation of fair value for the bonds. Therefore, the authors propose the use of three approaches with varying degree of difficulty, efficiency, etc. to price a typical callable convertible bond, together with the case application of a famous Vietnamese enterprise, Vincom Joint Stock Company. They are Lattice models including Binomial Tree and Trinomial Tree, Black-Scholes based Component model and Monte Carlo simulation.

Dividend-Protected Convertible Bonds and the Disappearance of Call Delay

Firms have not historically forced conversion as soon as possible. Explanations for the delay rely on the size of the dividends that bondholders forgo so long as they do not convert. Constantinides and Grundy (1986) posit that call delay can be optimal when the dividends to be received upon conversion are, or are expected to be, sufficiently large that convertible holders have an incentive to voluntarily convert. Asquith and Mullins (1991) introduce a corporate tax wedge between bondholder losses and shareholder gains and show that call delay can be optimal when the dividends to be received upon conversion exceed the after-tax coupon. We investigate an important change in convertible security design, namely that many recent convertible bond issues are dividend-protected. Dividend-protected convertibles are priced as if no dividends were paid by the firm and dividend-related rationales for call delay become moot. The optimal call policy for a dividend-protected convertible is that of Ingersoll (1977a) and Brennan and Schwartz (1977), namely call as soon as conversion can be forced. We examine the call decisions until 1-1-2011 for 432 callable convertible bonds issued in the period 2000 through 2006. Dividend protection for convertible bonds has increased in popularity over time: there are no dividend-protected convertible bonds in 2000, while 100 percent of the convertible bonds in our sample issued in 2005 are dividend-protected. We document that dividend-protected convertibles are called as soon as conversion can be forced and thus vindicate the original prediction of Ingersoll and of Brennan and Schwartz.

Adverse Selection and Convertible Bonds

Informational asymmetries between a firm and investors may lead to adverse selection in capital markets. This paper demonstrates that when the market obtains noisy information about a firm over time, this adverse selection problem can be costlessly solved by issuing callable convertible bonds with restrictive call provisions. Such securities can be designed to make the payoff to new claimholders independent of the private information of the manager. This eliminates the possibility of any dilution of equity or underinvestment and implements the symmetric information outcome in either a pooling or a separating equilibrium. The same first-best efficient outcome can also be implemented by issuing floating-price and mandatory convertibles.

Lattice Tree Methods for Strongly Path Dependent Options

This review article summarizes the applications of the forward shooting grid method to pricing of various types of strongly path dependent options. The forward shooting grid approach is characterized by augmenting an auxiliary state vector at each node in the usual lattice tree, which serves to capture the path dependent feature of the option. Examples of path dependent derivatives considered include the lookback options, Asian options, callable convertible bonds, and call options with strike reset feature.

Valuation of Callable Convertible Bond With Parisian Feature Using Finite Element Method

To protect the conversion privilege from being called away too soon, the bond indenture commonly contains hard constraint and soft constraint, which makes the valuation for the convertible bond more complicated. In this paper, a valuation model for a callable convertible bond with Parisian feature and notice period requirement is presented here using the arbitrage-free valuation method. Different from the existing works, we analyze the interaction between the optimal policy and the optimal conversion policy based on the game theory analysis of options. Moreover, the finite element method is adopted to solving the pricing model and the projected successive over-relaxation technique is used to handling the American constraint. Finally, the convertible bond issued by China Merchants Bank is taken for an example to illustrate how the model works. Results show that notice period and Parisian feature have significant effect on the value of convertible bond and the optimal policies, and the so called delayed call phenomena has got some explanations here.

Avaliação de títulos conversíveis com opções de compra e venda: uma aplicação dos métodos de simulação GVW e MQMC

The present paper values callable and redeemable convertible bonds by means of two of the most modern and efficient simulation methodologies for derivative pricing: Least Squares Monte Carlo (LSM) and Grant, Vora & Weeks (GVW). An attempt was made at the evaluation of the efficiency of the Monte Carlo Simulation Methodology considering its more recent features applicable to derivative pricing. A major challenge in this paper was the use of these two models in the valuation of complex convertible bonds, given that both were originally developed and used by their authors for regular American options. Therefore, the models were applied, and their results were compared to those

Valuation and optimal strategies of convertible bonds

This article presents a contingent claim valuation of a callable convertible bond with the issuer's credit risk. The optimal call, voluntary conversion, and bankruptcy strategies are jointly determined by shareholders and bondholders to maximize the equity value and the bond value, respectively. This model not only incorporates tax benefits, bankruptcy costs, refunding costs, and a call notice period, but also takes account of the issuer's debt size and structure. The numerical results show that the predicted optimal call policies are generally consistent with recent empirical findings; therefore, calling convertible bonds too late or too early can be rational. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:895–922, 2006

Pricing Convertible Bonds with Monte Carlo Simulation

This paper proposes a pricing model that values convertible bonds with Monte Carlo simulation. The optimal exercise boundaries for the embedded American-style conversion, call, and put options are inferred from the conditional expected value of continuation which is obtained by least-squares regressions in combination with a backward-induction procedure. The simulation-based pricing method is more flexible than traditional valuation approaches based on finite differences and binomial trees. It allows to better model the dynamics of the underlying state variables and to account for the specifications of the instrument, such as the path dependencies inherent in many callable convertible bonds. Credit risk is accounted for by directly modelling the possibility of default.

Analyzing Callable and Convertible Bonds when the Modigliani-Miller Assumptions are Violated

We analyze callable, convertible, and callable-convertible bonds in a dynamic model with restructuring, taxation, and transaction/bankruptcy costs. In this setting, calling when conversion value equals call price is not generally optimal. Late (early) calls are optimal when the conversion ratio is high (low) and the debt coupon is low (high). If volatility is fixed, pure callable bonds with a substantial call premium maximize firm value, committing equity to second-best restructuring policies. Convertibles are dominated in this context, since the backdoor equity component of the bond is tax-inefficient. The model is extended to allow for instantaneous risk shifting. Call provisions shorten effective maturity, but are not sufficient to induce hedging. Convertible bonds induce hedging, and the optimal conversion ratio trades off incentive provision against tax costs. Convertibles dominate pure callable bonds only when costs of risk shifting are sufficiently high. Although they mitigate risk shifting incentives, no convertible bond can induce global hedging, since equity is infinitely risk loving near default. In addition, convertible bonds exacerbate underinvestment incentives, since conversion privileges reduce marginal q.