Analysis of Convertible Bonds

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  • Topic: Bond, Convertible bond, Stock
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Analysis of Convertible Bonds
DECEMBER 14, 2008
With the repeal of the Capital Issues Control Act and the enactment of SEBI Act in 1992, the rules of the game applicable to convertible bonds have changed. As per SEBI guidelines issued in June 1992, the provisions applicable to fully convertible bonds and partially convertible binds are as follows:

* The conversion premium and the conversion timing shall be predetermined and stated in the prospectus. * Any conversion partial or full will be optional at the hands of the bond holder, if the conversion takes place at or after 18 months but before 36 months from the date of allotment. * A conversion period of more than 36 moths will not be permitted unless conversion is made optional with ‘put’ and ‘call’ options * Compulsory credit rating will be required if the conversion period for fully convertible bonds exceeds 18 months. From the SEBI guidelines it is clear that convertible bonds in India presently can be of three types:

(a) Compulsorily convertible bonds which provide for conversion within 18 months. (b) Optionally convertible bonds which provide for conversion within 36 months. (c) Bonds which provide for conversion after 36 moths but which carry ‘call’ and ‘put’ features. My guess is that the bulk of the convertible bonds in the immediate future will be of types (a) and (b). Hence, our discussion on valuation of convertible bonds will focus on these two types.

Valuation of Compulsorily Convertible (Partly or Fully) bonds

If you own a compulsory convertible (partly or fully) bond you receive: * A certain number of equity shares on part /full conversion * A certain stream of interest and principal repayments.
Hence the value of such a bond is equal it the sum of two components: * The present value of equity shares receivable on conversion * The present value of interest and principal payments receivable on the bond Valuation of optionally Convertible Bonds:

An optionally...
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