Straight Bonds Research Articles

Can existing corporate finance theories explain security offerings during the COVID-19 pandemic?

We document substantial increases in corporate security offerings during the COVID pandemic. While the increase in seasoned equity offerings (SEOs) can be attributed to shifts in macroeconomic conditions, increases in convertible and straight bond offerings cannot be explained by standard security choice determinants. We furthermore find that COVID-period SEO announcements are often contaminated with Research and Development (R&D)-related news, with the SEO proceeds more likely to be hoarded as cash. Overall, COVID-period SEOs align with market timing behavior, but the increase in COVID-period convertibles and straight bonds cannot be reconciled with pre-pandemic corporate financing rationales or government interventions. We furthermore demonstrate that the COVID pandemic differs substantially from the Global Financial Crisis (GFC) in terms of security offering choices and announcement returns.

Convertible bond maturity and debt overhang

We develop a dynamic corporate investment model to investigate the determinants of the optimal maturity structure of convertible bonds and its debt overhang effect. Our model predicts that relative to the issuance of straight bonds, companies opting for short-term (long-term) convertible bonds tend to expedite (delay) their investment activities, thereby alleviating (exacerbating) issues related to underinvestment. This outcome provides a theoretical rationale for the observed trend of decreasing convertible bond maturity, as explained by debt overhang theory. Moreover, contrary to previous findings, a growth company optimally chooses to issue convertibles with shorter maturities when it has fewer valuable growth opportunities. These insights improve our understanding of the interactions between convertible bond maturity and corporate investment.

Pricing contingent convertibles with idiosyncratic risk

AbstractWe consider capital structure including equity, straight bonds (SBs), and contingent convertibles (CoCos) for nonfinancial firms. We price equity and CoCos by a utility‐based method. We show that benefits from issuing CoCos increase dramatically with idiosyncratic risk and risk aversion. The firm value is concave in CoCos' conversion ratio and the optimal conversion ratio increases with risk aversion and idiosyncratic risk. If risk aversion is sufficiently high, shareholders' risk‐shifting incentives disappear, and the firm issues less CoCos and equity and more SBs as idiosyncratic risk rises. The higher the idiosyncratic risk or risk aversion, the higher the leverage.

The impact of CEO education on convertible bond issuance

We examine the impact of managerial education on a firm’s decision to issue convertible bonds instead of standard, non-hybrid securities. Upper echelons theory argues that better managerial education attainment fosters a higher ability to process complex information and tolerate ambiguity. Exploiting convertible bonds’ higher degree of complexity, relative to seasoned equity and straight bonds, we hypothesise that Chief Executive Officers (CEOs) with higher education levels are more likely to issue convertible bonds instead of non-hybrid security types. A multinomial probit model analysing firms’ choice between convertibles, seasoned equity, and straight bonds provides evidence consistent with this hypothesis. A one-level increase in a CEO’s highest academic degree raises the likelihood of substituting convertibles for non-hybrid securities by 2.86%, after controlling for standard corporate security choice determinants. Chief Financial Officer (CFO) education levels, by contrast, have no significant impact on convertible bond issuance. Consistent with higher managerial education attainment being associated with a higher cognitive ability, we also find a positive association between CEO education levels and the level of complexity in convertible bond design. Our findings, which hold under a range of alternative specifications, illustrate the influence of CEOs’ personal characteristics on securities issuance and design.

Dimerization of Paramagnetic Trinuclear Complexes by Coordination Geometry Changes Showing Mixed Valency and Significant Antiferromagnetic Coupling through -Pt···Pt- Bonds.

Paramagnetic trinuclear complexes, trans-[Pt2M(piam)4(NH3)4](ClO4)x (t-M; piam = pivalamidate, M = Mn, Fe, Co, Ni, and Cu, x = 2 or 3), aligned as Pt-M-Pt were successfully synthesized and characterized. The dihedral angles between the Pt and M coordination planes in t-M are approximately parallel, showing straight metal-metal bonds with distances of approximately 2.6 Å. Except for t-Fe, the trinuclear complexes are dimerized with close contact (approximately 3.9 Å) between the end Pt atoms to form Pt-M-Pt···Pt-M-Pt alignments with high-spin M(+2) containing five (t-Mn), three (t-Co), two (t-Ni), and one (t-Cu) unpaired electrons localized on M atoms. Several physical measurements and calculations revealed that the dimerized structures were maintained in MeCN, where cyclic voltammograms for t-M exhibited two-step oxidation and reduction attributed to Pt-M(+2)-Pt···Pt-M(+2)-Pt ↔ Pt-M(+3)-Pt···Pt-M(+2)-Pt ↔ Pt-M(+3)-Pt···Pt-M(+3)-Pt via mixed-valent states. Magnetic susceptibility measurements for t-M showed antiferromagnetic interaction, t-Mn: J = -0.9 cm-1, t-Co: J = -3.5 cm-1, t-Ni: J = -7.3 cm-1, and t-Cu: J = 0.0 cm-1, between the two M centers with distances of 9.0 Å through Pt···Pt bonds.

Structured product investment behavior in low-interest rate environments

PurposeThis study aims to investigate the impact of interest rates, the underlying asset and investment experience on the investment behavior of Japanese retail investors toward structured products (SPs).Design/methodology/approachThree treatments are constructed through internet-based survey experiments: interest rate, underlying asset framing and investment experience treatments. The interest rate treatment includes high- and low-interest rate environments. The underlying asset framing treatment includes equity and foreign exchange rates for the SP. The investment experience treatment includes experienced and inexperienced respondents for SPs.FindingsThe main finding of this study concerns the effect of the interaction between low-interest rates and investment experience. Specifically, SP-experienced investors tend to choose SPs in a low-interest rate environment and prefer equity-linked SPs, even though such SPs are overpriced. This finding is useful for financial regulators in formulating policies that protect retail SP investors in low-interest rate environments worldwide.Originality/valueThis study is the first to measure the sensitivities of investment behavior regarding the relative attractiveness of SPs to low-risk straight bonds, given interest rates, the underlying asset and investment experience. It provides evidence to support the development of SP regulations.

On Write-Down/ Write-Up Loss Absorbing Instruments

Purpose: The article deals with banks' vulnerability to insolvency. We discuss the impact of the CoCo write-down/write-up bonds issuance on the bank solvency. Such instruments absorb losses in two ways: 1) When a bank gets in trouble, the payment of interest is ceased, and 2) If the financial standing of the bank further deteriorates, its CoCo bonds are written down. Reversing it, when the bank solvency improves, the CoCos are gradually written up, and the payment of interest is restored. The investment in the CoCo bonds is risky. That is why they offer a greater interest rate than straight bonds. Hence there is a trade-off: loss absorption versus profitability. Design/Methodology /Approach: As a measure of insolvency, we consider the probability of the implementing resolution process, i.e., as it is called in actuarial sciences, the probability of ruin. Findings: We show that depending on the CoCo bonds' profitability, the additional issuance of the CoCos may reduce the probability of ruin. In this respect, we propose a theoretical explanation for the optimum share of CoCos in an institution's liabilities. Practical implications: Our findings may give the supervisory authorities a useful tool to determine the fair share of Additional Tier One (AT1) CoCos to fill the Pillar 2 bank capital layer. The model proves to be useful for setting the optimum size of Restricted Tier One (RT1) CoCos in the insurer's liabilities as well. Originality/value: The science lacks theoretical background for CoCos' optimal size in issuers' liabilities. Besides, we provide a new measure of bank insolvency. Contrary to the typical approach with a finite time horizon, we choose the default probability at any moment in the future as a measure of insolvency.

The Pricing of Bank Bonds, Sovereign Credit Risk and ECB’s Asset Purchase Programmes

The 2008 Global financial crisis and the subsequent European sovereign debt crisis deteriorated banks funding conditions and lead to a substitution effect among bond instruments. We examine the pricing of straight, covered and securitization bonds issued by European banks in the 2000-2016 period, with a particular focus on the effect of sovereign credit risk and ECB’s asset purchase programmes on spreads. We find that (i) straight, covered and securitization bonds are priced in segmented markets, (ii) the impact of common pricing determinants on spreads differ significantly between non-crisis and crisis periods, (iii) sovereign credit risk is an important determinant of banks’ cost of funding, especially in crisis periods, (iv) ECB’s asset purchase programmes exhibited mixed effectiveness in improving banks funding conditions, (v) contractual bond characteristics other than credit ratings, macroeconomic factors and bank characteristics are important determinants of spreads, and (vi) there is evidence of heterogeneity across countries.

The relationship of G-Index and convertible debt issuance in the presence of restrictive covenants

We examine the relationship between the Governance Index (G-Index) and convertible bond use by firms, specifically in the presence or absence of covenants. We find that the better the shareholder governance (lower G-Index) of firms, the more they are likely to issue convertible instead of straight bonds. More importantly, we find that the complementary relationship between shareholder governance and convertible bond use is driven by the existence of certain covenants attached to these convertible securities. We also find that this effect is accentuated in firms with smaller size, higher market-to-book, R&D and intangibles as well as higher beta. We conclude that this link between strong shareholder rights and increased convertible bond use is conditional on the presence of covenants and therefore shows the important interaction of these three governance mechanisms. In addition, this triple link being emphasized in firms with higher agency costs and adverse selection problems is consistent with value-maximizing use of convertible bonds.

The Announcement Effect of Junk Bond Issues: an Analysis of the 1976-1989 Period

This paper analyzes the impact of corporate junk bond offering announcements on stock prices for a sample of 680 issues of below investment grade bonds, during the 1976-1989 period. The sample shows a -1.0% cumulative abnormal return (CAR) for a two day event window period, and the zero CAR hypothesis is rejected with 99% confidence. The cumulative abnormal returns are negative and significant for combined announcements of bond and equity issues (CAR of -2.10%), and for announcements of convertible bond issues (CAR of -1.24%). Announcements of issues of straight bonds (CAR of -0.24%) are not significantly different from zero. Differences in CARs are observed across subsamples formed on the basis of size of the issuer, relative size of the issue, rating of the issue, name of the underwriter, market value of the issuer, and year of issue, but these variables are not significant when used in cross sectional regressions. The only variables with some explanatory power in those regressions are the ones indicating type of the issue, recession periods, and the dummy used to identify announcements made in 1976 (the first year junk bond issues were allowed).

The Nitty Gritty of Bond Valuation

The multitude of day count conventions and the prevalence of irregular coupon periods constitute a major complication for the comparative analysis of interest accruing securities across markets. I develop the first generalized pricing methodology for straight bonds that allows for irregular coupon periods of any length and precisely accounts for any conceivable day count convention. In a comprehensive compendium, I distinguish between the individual conventions, relating them to each other in a consistent mathematical notation. Using one universal valuation formula, I derive closed form solutions for modified duration and convexity. My R-Package Bond Valuation closes the gap between theory and data.

Sukuk announcement effects during financial crisis: the case for Indonesia

PurposeThe effects of capital-raising announcements have long been used as an indicator of increased shareholder wealth (Brown and Warner, 1985). Studies on bond announcements, for example, have been largely inconclusive. However, when effects are measured based on bond underlying structure, “straight and convertible bonds”, then the results are more conclusive (Abdul Rahim, 2012). Furthermore, issuances around crisis period are expected to result in negative market reaction as investors prefer liquidity (Fenn, 2000).Design/methodology/approachSukuk are bond-like instruments that are issued based on the Sharia guidelines and perceived to be less risky due to their risk sharing attribute. Sukuk are issued by the governments and also corporations. Sukuk can either be debt-based or equity-based. The former resembles the conventional bond, and equity-based Sukuk resembles the convertible bonds. It is interesting to ascertain the market reaction to issuance of both type of Sukuk. This study determines the wealth effects of debt-based Sukuk issuances in Indonesia, around crisis period. Sukuk issues have steadily increased in Indonesia, and it is the second largest issuer in 2015 (Zawya, 2015a, 2015b).FindingsThe market reaction to corporate Sukuk issuance by Indonesian firms is yet to be documented, and the findings of this study address this issue, especially during the crisis period when the risk aversion is high and investors prefer liquidity. The Bai and Perron’s (2003) multiple breakpoint analysis was applied to determine the crisis period, which was between 2007 and 2010.Originality/valueThe findings suggest that the market reacts positively and significantly to debt-based Sukuk issuance during the crisis period, contrary to the theory that postulates a negative market reaction. Though these findings seem to be unique, it is possible that it is a behavioral effect of investors requiring less liquidity premium during crisis, contrary to expectations (Chen et al., 2007; Amihud and Mendelson, 1986).

Chinese write-down bonds and bank capital structure

In this paper, we use a structural model to investigate a bank capital structure that contains deposits, straight bonds, Write-Down (WD) bonds and equity. We first explicitly give the default boundaries and the values of a deposit, straight bond, WD bond, equity and bank asset, and then use a numerical example to demonstrate the relations among leverage, deposits, WD bonds and bank value. Our results show that value-maximizing banks select the ratio of deposit, straight bond and WD debt so that endogenous default is consistent with exogenous bank closure. The bank increases its leverage by swapping both deposits and straight bonds for WD bonds. And the issuance of WD bonds not only reduces the expected bankruptcy loss and credit spread of straight bonds, but also improves the bank value. This indicates that WD bonds do help to stabilize banks. We also study the role of deposit insurance and the Chinese Financial Stability Bureau (FSB), and give a closed-form expression for the fair insurance premium. Lastly, to check the robustness of our results, we do the sensitivity analysis and investigate the effect of three sets of exogenous parameters on bank capital structure: WD parameters, bank business features, closure rules and insurance subsidy, and obtain some practically significant implications.

Yields versus Expected Returns of Corporate Bonds: Some Unexpected Results

We derive expected bond return equations for various structural credit valuation models with alternative stochastic processes and boundary conditions for default given in Merton [1974], Merton [1976], Black and Cox [1976], Heston [1993], Longstaff and Schwartz [1995], and Collin-Dufresne and Goldstein [2001]. We investigate the relationship between bond yields and expected returns under each of these models. We show that for the case of low leverage, bond yields are inversely related to expected returns for a range of maturities that lie beyond the hump of the term structure of bond yields. We also show that for the bonds of same maturity, the option characteristics of the bonds often lead to an inverse relation between bond yields and expected returns. For example, callable bonds have higher yields, but lower expected returns, than the corresponding yields and expected returns of the underlying straight bonds. Convertible bonds have higher yields but lower expected returns for the case of high leverage, and lower yields but higher expected returns for the case of low leverage, than the corresponding yields and expected returns of the underlying straight bonds.

Yields versus Expected Returns of Corporate Bonds: Some Unexpected Results

We derive expected bond return equations for various structural credit valuation models with alternative stochastic processes and boundary conditions for default given in Merton [1974], Merton [1976], Black and Cox [1976], Heston [1993], Longstaff and Schwartz [1995], and Collin-Dufresne and Goldstein [2001]. We investigate the relationship between bond yields and expected returns under each of these models. We show that for the case of low leverage, bond yields are inversely related to expected returns for a range of maturities that lie beyond the hump of the term structure of bond yields. We also show that for the bonds of same maturity, the option characteristics of the bonds often lead to an inverse relation between bond yields and expected returns. For example, callable bonds have higher yields, but lower expected returns than the corresponding yields and expected returns of the underlying straight bonds. Convertible bonds have higher yields but lower expected returns for the case of high leverage, and lower yields but higher expected returns for the case of low leverage, than the corresponding yields and expected returns of the underlying straight bonds.

Real options and contingent convertibles with regime switching

We consider a firm with no assets in place but an option to invest in a project. The investment is irreversible but delayable in a regime-switching economy. The firm issues equity, straight bonds (SBs) and contingent convertibles (CoCos). We provide the closed-form prices for the firm׳s securities and the pricing and timing of the option. Our numerical analyses discover that issuing CoCos instead of SBs induces much less agency cost of debt. The agency cost is higher in a boom economy than in recession but the difference is small. There is a unique CoCos׳ conversion ratio such that the agency cost arrives at the minimum value zero. The inefficiencies arising from asset substitution and debt overhang are much more significant in recession than in boom. Only if the conversion ratio is not too small, the two inefficiencies disappear during boom periods. While the effects of the conversion rate on optimal capital structure and firm value and those of supervision and jump intensity on optimal CoCos׳ coupon are ambiguous and weak, the stricter the supervision or the longer the economy remains in recession, the less the option value and the optimal SBs׳ coupon.

Real Options and Contingent Convertibles with Regime Switching

We consider a firm with no assets in place but an option to invest in a project. The investment is irreversible but delayable in a regime-switching economy. The firm issues equity, straight bonds (SBs) and contingent convertibles (CoCos). We provide the closed-form prices for the firm's securities and the pricing and timing of the option. Our numerical analyses discover that issuing CoCos instead of SBs induces much less agency cost of debt. The agency cost is higher in a boom economy than in recession though the difference is small. There is a unique CoCos' conversion ratio such that the agency cost arrives at the minimum value zero. The inefficiencies arising from asset substitution and debt overhang are much more significant in recession than in boom. Only if the conversion ratio is not too small, the two inefficiencies disappear during boom periods.

A new finite difference method for pricing and hedging fixed income derivatives: Comparative analysis and the case of an Asian option

We propose a second order accurate numerical finite difference method to replace the classical schemes used to solve PDEs in financial engineering. We name it Modified Fully Implicit method. The motivation for doing so stems from the accuracy loss while trying to stabilize the solution via the up-wind scheme in the convective term as well as the fact that spurious oscillations solutions occur when volatilities are low (this is actually the range that is commonly observed in interest rate markets). Unlike the classical schemes, our method covers the whole spectrum of volatilities in the interest rate dynamics.We obtain analytical and numerical results for pricing and hedging a zero-coupon bond and an Asian interest rate option. In the case of the Asian option, we compare the realistic discrete compounding interest rate scheme (associated with the Modified Fully Implicit method) with the continuous compounding scheme (often exploited in the literature), obtaining relative discrepancies between prices exceeding 50%. This indicates that the former scheme is more appropriate then the latter to price more complicate derivatives than straight bonds.

Write-Down Bonds and Capital and Debt Structures

We analyze a defaultable firm’s optimal capital and debt structures when its debt includes senior straight and Write-Down (WD) bonds. Credit events and premature or terminal bankruptcy are triggered if the firm’s asset value hits specific barriers. The optimal capital structure and the optimal straight/WD debt mix are jointly determined along with the optimal level of debt reduction. The firm increases its leverage by swapping both equity and straight debt for WD bonds. The credit spread on the straight debt is shown to be considerably lower when the firm’s capital structure also includes WD bonds, for a given global leverage.

Obligacje w walucie obcej. Struktura i funkcjonowanie instrumentu

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