lev-os Analyzing Equity Linked Instruments
Evaluates convertible bond and mandatory convertible structures with equity sensitivity, credit floor, and Greeks analysis.
When To Use
- Pricing or reviewing a new convertible bond offering (vanilla, mandatory, contingent)
- Assessing conversion economics for an existing equity-linked instrument
- Comparing convertible structures across issuers or maturities
- Modeling sensitivity of instrument value to equity price, volatility, or credit spread changes
- Evaluating investor returns under various stock-price and credit scenarios
Inputs To Gather
- Instrument terms: coupon rate, maturity, conversion price, conversion ratio, call/put provisions, reset features, contingent conversion triggers
- Issuer data: current stock price, historical and implied volatility, dividend yield, credit rating, outstanding debt structure
- Market data: risk-free rate curve, credit spread curve for issuer or comparable credits, equity borrow cost
- Structure type: vanilla convertible, mandatory convertible (PERCS, DECS, MCPS), exchangeable, contingent convertible (CoCo)
- Analysis scope: full valuation, relative value comparison, scenario analysis, or Greeks snapshot
Workflow
Classify the instrument
- Identify structure type (vanilla convertible, mandatory convertible, CoCo, exchangeable)
- Map key embedded options: equity call, issuer call, investor put, reset provisions, contingent triggers
- Note any non-standard features (make-whole, dividend protection, change-of-control puts)
Decompose into components
- Bond floor (credit component): discount contractual cash flows at the issuer's credit spread to derive straight-debt value
- Equity option component: value the embedded conversion right using a binomial tree or Black-Scholes variant adjusted for dilution, dividends, and call features
- For mandatory convertibles, model the capped-call / written-put payoff structure (upper and lower strike boundaries)
- For CoCos, incorporate trigger probability modeling (mechanical vs. discretionary triggers) [VERIFY: trigger type and loss-absorption mechanism — write-down vs. conversion]
Calculate key metrics
- Conversion premium: (conversion price / current stock price − 1) × 100
- Bond floor premium: (market price / bond floor − 1) × 100
- Investment premium: (market price / parity − 1) × 100
- Break-even period: conversion premium ÷ (coupon yield − dividend yield on equivalent shares)
- Parity: conversion ratio × current stock price
- Expected yield: YTM on bond floor, current yield on convertible
Run Greeks and sensitivity analysis
- Delta: sensitivity of convertible price to underlying equity moves
- Gamma: rate of change of delta as equity moves
- Vega: sensitivity to implied volatility changes
- Rho (credit): sensitivity to credit spread widening/tightening
- Theta: time decay of the embedded option
- Produce an equity sensitivity table: convertible value at stock prices ±5%, ±10%, ±20%, ±30% from spot
Assess credit floor integrity
- Verify bond floor using issuer credit spread or CDS levels [VERIFY: use issuer-specific CDS if available vs. synthetic spread]
- Stress-test bond floor under 100bp, 200bp, and 500bp spread widening scenarios
- Evaluate recovery assumptions if issuer is below investment grade
- Flag instruments where parity is far below bond floor (busted convertibles) or far above (equity-like behavior)
Scenario and relative-value analysis
- Model bull/base/bear equity scenarios and map convertible returns vs. straight equity and straight debt
- Compare conversion premium, delta, and break-even across peer issuances
- For mandatory convertibles, chart payoff profile showing capped upside and full downside participation below lower strike
Compile findings
- Summarize instrument profile: equity-sensitive, balanced, or credit-sensitive positioning
- Highlight asymmetric return features (downside protection via bond floor, upside participation via delta)
- Note risks: call risk, credit deterioration, dividend changes, volatility crush, dilution impact on common shareholders
- Flag any terms requiring issuer-level or regulatory verification
Output
- Instrument Summary Table: structure type, key terms, conversion metrics (premium, parity, break-even)
- Valuation Breakdown: bond floor value, equity option value, theoretical fair value vs. market price (cheap/rich indicator)
- Greeks Dashboard: delta, gamma, vega, credit rho, theta at current spot
- Equity Sensitivity Grid: convertible price and delta across a range of stock prices
- Credit Stress Table: bond floor and total value under spread-widening scenarios
- Scenario Returns Matrix: convertible total return vs. equity return under bull/base/bear
- Risk Flags: call features approaching trigger, thin bond-floor cushion, upcoming dividend changes, liquidity concerns
Quality Checks
- Confirm bond floor does not exceed market price (if it does, verify credit assumptions or flag potential arbitrage)
- Validate that delta falls between 0 and 1, and that delta + bond-floor-weight ≈ 1 for properly decomposed instruments
- Verify break-even calculation uses the correct yield advantage (coupon minus forgone dividends)
- Cross-check conversion ratio and conversion price are consistent with prospectus terms [VERIFY: confirm against offering circular or indenture]
- Ensure Greeks are internally consistent (e.g., higher delta for lower conversion premiums, gamma peak near at-the-money)
- For mandatory convertibles, confirm payoff replicates the correct collar structure (long stock + short call + long put, or equivalent)
- Mark any assumed volatility, credit spread, or dividend inputs with source and as-of date