CaseMark Analyzing Convertible Bonds
When To Use
- Evaluating a new convertible bond issuance for investment suitability
- Calculating conversion premium, parity, and breakeven horizon for an existing position
- Determining the credit floor (bond floor / investment value) to assess downside protection
- Analyzing equity sensitivity (delta) and Greeks for hedging or relative-value trades
- Comparing convertible structures across issuers or maturities (mandatory vs. optional conversion, contingent conversion triggers, make-whole provisions)
- Assessing forced-conversion risk or call-spread overlay economics
Inputs To Gather
- Bond terms: coupon rate, maturity, par value, conversion ratio, conversion price, call schedule (hard call / soft call dates and prices), put schedule if any
- Issuer credit profile: credit rating (Moody's/S&P/Fitch), CDS spread or comparable straight-debt spread, sector, leverage metrics
- Equity data: current stock price, dividend yield, historical and implied volatility, borrow cost
- Market data: risk-free rate curve, credit spread curve for the issuer's rating tier, recovery assumption
- Structure specifics: contingent conversion (CoCo) triggers, make-whole fundamental change provisions, cash/share/combo settlement, reset features, cap/floor on conversion ratio
- Portfolio context (if applicable): existing equity or credit exposure to the issuer, hedging objectives
Workflow
Parse the indenture terms
- Extract conversion ratio, conversion price, coupon, maturity, call/put schedule, and any contingent features
- Identify settlement method (physical, cash, net-share) — this affects delta hedging and tax treatment [VERIFY: settlement method and tax treatment vary by jurisdiction]
Calculate core metrics
- Conversion parity = conversion ratio × current stock price
- Conversion premium = (bond price − parity) / parity, expressed as %
- Premium payback period = conversion premium / (coupon yield − dividend yield on equivalent shares); flag if dividend yield exceeds coupon yield (negative carry)
- Bond floor (investment value) = PV of coupon and principal cash flows discounted at issuer's straight-debt yield; this is the credit floor
- Risk premium over bond floor = (bond price − bond floor) / bond floor
Assess equity sensitivity and Greeks
- Delta: estimate via a convertible pricing model (binomial tree or Black-Scholes adjusted for credit) — typical ranges: busted (<0.2), hybrid (0.3–0.7), equity-like (>0.8)
- Gamma: rate of delta change; highest near the conversion price — relevant for gamma-trading strategies
- Vega: sensitivity to implied vol; long vega is a core convertible feature
- Rho: interest-rate sensitivity of the bond floor component
- Theta: time decay of the embedded option; accelerates approaching maturity or hard-call date
Evaluate credit component
- Compare bond floor to par to gauge downside cushion
- Stress-test the bond floor under spread-widening scenarios (+50 bps, +100 bps, +200 bps)
- Assess recovery value assumption in default scenario (typically 30–40% for unsecured converts) [VERIFY: recovery assumptions against current sector norms]
Analyze call and put features
- Determine if the issuer can force conversion (stock trading above call price × conversion ratio for required period)
- Calculate probability-weighted expected life given soft-call triggers
- Evaluate investor put rights and their impact on yield-to-put vs. yield-to-maturity
Run scenario analysis
- Upside: stock +20%, +50% — compute bond price, delta shift, and forced-conversion likelihood
- Downside: stock −20%, −50% — compute bond price vs. bond floor, credit deterioration risk
- Spread scenarios: parallel shift in credit spreads, rating downgrade impact on bond floor
- Volatility scenarios: vol crush (−10 pts) and vol spike (+10 pts) effect on theoretical value
Relative-value comparison (if applicable)
- Compare cheapness/richness vs. theoretical value from a pricing model
- Benchmark against comparable convertibles (same sector, similar delta profile)
- Assess vs. synthetic alternative (buying straight bond + equity call option)
Output
Structure the analysis report as follows:
- Summary: one-paragraph investment thesis — is this convert cheap/fair/rich, and what profile does it offer (equity substitute, credit-plus-optionality, busted/distressed)?
- Term sheet recap: key terms in tabular format (coupon, maturity, conversion price/ratio, call schedule, settlement)
- Valuation metrics table: parity, premium, premium payback, bond floor, risk premium over floor, delta, gamma, vega, theoretical value, cheap/rich assessment
- Scenario matrix: bond price, delta, and P&L under the equity/credit/vol scenarios above
- Risk factors: forced-conversion risk, credit deterioration, dividend increases reducing option value, liquidity risk, structural subordination
- Recommendation / positioning: buy/sell/hold with sizing context, or hedging recommendation (e.g., delta-neutral, credit-hedged)
Quality Checks
- Verify conversion ratio and conversion price are internally consistent (par / conversion price = conversion ratio)
- Confirm bond floor is calculated using the issuer's straight-debt spread, not the risk-free rate
- Ensure delta and Greeks are derived from a model that incorporates credit risk (not plain Black-Scholes on a risk-free basis)
- Check that premium payback calculation correctly handles the sign when dividend yield exceeds coupon yield
- Validate call schedule dates against the indenture — soft-call trigger conditions (e.g., stock trading above 130% of conversion price for 20 of 30 trading days) must be stated precisely [VERIFY: exact trigger language from the indenture]
- Cross-check theoretical value against at least one independent source or model
- Flag any make-whole or change-of-control provisions that materially affect valuation