Reverse Convertible Bond

In the case of reverse convertible bonds, the issuer has the right to deliver a certain quantity of stock on the due date instead of repaying the nominal amount. Which stock the issuer delivers is determined in advance.

The issuer delivers stock if the value of the stock is lower than the value of the nominal amount of the bond. Reverse convertible bonds can therefore be split into a bond and a put option on the underlying stock.

In order to valuate reverse convertible bonds, you must create them as generic transactions.

Prerequisite

You have created the security classes for the bond and the stock in Treasury. A financial object exists for the bond.

Procedure

To depict a reverse convertible bond as a generic transaction, create the following elementary transaction hierarchy:

This graphic is explained in the accompanying text.

Create the hierarchy as follows:

Create a new generic transaction. Assign the generic transaction status 9 (class supplement). Enter the security ID number in the master data of the generic transaction. See Edit Generic Transaction for the procedure.
1. .
In the dialog structure, select the first elementary transaction and assign to it transaction form 300 (complex class) .

Select the elementary transaction in the dialog structure again.

The system displays the tab page for the corresponding header information.

Enter the issue date of the bond in the Start of term field.
Create a transaction with transaction form 402 (reference to ID number) under the Complex Class elementary transaction. To do this, select the Complex Class elementary transaction in the dialog structure and choose Create Elementary Trans.: Next Level . Select the new elementary transaction and assign to it transaction form 402.

Select the required elementary transaction in the dialog structure again.

The system displays the tab page for the corresponding header information.

Enter the object number of the bond in the ID Number field. You can use input help to select the transaction.
Create a transaction with transaction form 61 (OTC option) under the Complex Class elementary transaction. (Proceed as for step 3).

The system displays three tab pages.

Enter the following information on the Header Information tab page:
- Start of term field.
  
  Issue date of the bond
- Notification By field
  
  Due date of bond
- Purchase/Sale field
  
  Set the indicator to Sale.
  
  On the Options Information tab page, flag the option as a standard option with European exercise and, in particular, as a put option. Enter the following information:
- Strike Currency field
  
  Currency of the bond
- Delivery of Underlying field
  
  Due date of bond
- Quotation of Underlying field
  
  Direct quotation
  
  You do not need to make any entries on the Cash Flow tab page.
Create a transaction with transaction form 10 (stock) under the OTC Option elementary transaction. (Proceed as for step 3).

Select the required elementary transaction in the dialog structure again.

The system displays the tab page for the corresponding header information.

Enter the security ID number, the exchange, enter the Direct quotation quotation type, and enter the number of units. Flag the transaction as a spot transaction and a purchase/investment.
Choose Back and then Save .

Result

You have created a reverse convertible bond as a generic transaction.

The system does not generate a financial object when you save even if automatic financial object integration is active. You have already created a financial object for the bond.

Example

A bank is the issuer of a reverse convertible bond. The bond is issued on 07/17/2002. The bond class with security ID number329706 gives the issuer the right to repay the class with 18 units of company A’s stock instead of EUR 10,000 on 08/17/2004. Company A’s stock has the security ID number 840400. The issuer pays an interest rate of 8.75%, (which is higher than the market interest rate) for this right.

From the investor’s perspective, this class can be split into a bond with the corresponding interest and repayment structure, and the sale of a put option. The put option is of the European exercise type, its term end is 08/17/04, and its strike is EUR 10,000 for 18 units of stock.

The following tables contain the entries that you would have to make for the generic transaction and the elementary transactions for this example.

Generic TransactionMaster Data

Tab Page	Field	Example of Contents	Comment
Master Data	Security ID Number	329706	Security ID number of bond
Master Data	Short Name	8.75%	Appropriate name for reverse convertible bond
Master Data	Status	9	Generic transaction is class supplement

Complex ClassElementary Transaction

Tab Page	Field	Example of Contents	Comment
Header Information	Start of Term	07/17/2002	Issue date of the bond

Reference to ID NumberElementary Transaction

Tab Page	Field	Example of Contents	Comment
Header Information	Security ID Number	329706	Security ID number of bond

OTC OptionElementary Transaction

Tab Page	Field	Example of Contents	Comment
Header Information	Start of Term	07/17/2002	Issue date of the bond
Header Information	End of Term	08/17/2004	Due date of bond
Header Information	Purchase/Sale	200	Sale
Options Information	Option Category	1	Standard option
Options Information	Exercise Type	1	European exercise type
Options Information	Put/Call Indicator	1	Put, as the issuer has the option of selling stock to repay the bond
Options Information	Strike amount	10,000	Nominal amount of bond
Options Information	Strike Currency	EUR	Currency of the bond
Options Information	Delivery of Underlying	08/17/2004	Due date of bond
Options Information	Quotation of Underlying	Direct quotation

StockElementary Transaction

Tab Page	Field	Example of Contents	Comment
Header Information	Spot/Forward	1	Spot transaction
Header Information	Purchase/Sale	100	Purchase/investment
Header Information	Security ID Number	840400	Security ID number of stock
Header Information	Exchange	FFM	Frankfurt am Main
Header Information	Quotation Type	2	Direct quotation
Header Information	Number of Units	18	Number of units of stock