Handbook of Hybrid Instruments

Hybrid instruments - essentially bonds with an equity component - are found in a multitude of guises. This generic heading encompasses a seemingly endless array of finance instruments, including convertible bonds, mandatory convertibles, reverse convertibles, preferred shares, ELKS, DECS and LYONs, Within each one of these instruments are found a wide range of variations and features. These include reset, negative pledge, screw and forced conversion clauses, as well as step up coupons, call schedules, call options with soft and hard protection, etc,

The range of possibilities can seem bewildering, but it is this very flexibility which proves a huge attraction for investors, issuers and financial institutions. On the sell side companies issue these securities and corporate service departments advise on the type of options to include in them. On the buy side, investment managers seek to build portfolios with limited risk exposure using these securities and hedge funds utilize arbitrage opportunities between the convertible bond and the common share.

The opportunities are endless but the seemingly labyrinthine complexities can prove daunting. The Handbook of Hybrid Instruments helps steer a clear path through the maze. Izzy Nelken has drawn together a team of experts to provide in-depth analysis of many o key issues that both sellers and buyers require in order to operate effectively and profitably.

A general introduction is followed by specific information on key clauses and variations, valuation methods, the impact on a firm's value following the public issuance of convertibles, details on when an issuer should call a convertible and the impact of these provisions on the price, the difficult requirement of input data to make sense of the models, indexes and reset convertibles. Finally, a highly useful glossary is provided of all the key terms used in this field.

An analytical CD is also provided with the book, containing sample software of ConvB++. This combines complex state of the art models with a simple, user-friendly interface to assess fair values prices and to hedge parameters of hybrid instruments.

The Handbook of Hybrid Instruments is an indispensable explanatory and analytical tool for all professionals looking for the latest thinking on convertibles from some of the world's leading expertsHybride Finanzierungsinstrumente kombinieren die Sicherheit eines fest verzinslichen Wertpapiers mit der Möglichkeit, Kursschwankungen an den Finanzmärkten ausnutzen zu können. Sie haben sich schnell zu einem wichtigen Element der Finanzwelt entwickelt, und es gibt sie in einer großen Formenvielfalt. Der Umgang mit hybriden Instrumenten erfordert spezielle Techniken, die sich aus der genauen Analyse der jeweiligen Instrumente ergeben. Nur so kann der Anleger sichere Gewinne einfahren. Das "Handbook of Hybrid Instruments" bietet Anlegern ausführliche Informationen über Analysemethoden und -techniken aus Wissenschaft und Praxis. List of Contributors

About the Contributers

Introduction

1.1 General

1.2 Importance of Adequate Analysis

1.3 Description of the Chapters

1.4 Summary

1 Hybrid Instruments: Advantages and Disadvantages, Badari S. Ewar

1.1 Introduction

1.2 What is a Convertible Bond?

1.3 The Issuer

1.4 The Investor

1.5 Terminology

1.6 Convertible Instruments

1.7 Summary

2 Convertible Structures: Evolution Continues, T. Anne Coxe

2.1 Convertible Bonds and Preferreds: Hybrid Vigor

2.2 LYONs: A Breed Apart

2.3 TOPrS: Preferreds made Better

2.4 MIPS: Predecessor to TOPrS

2.5 PERCS and Their Relatives

2.6 PRIDES: Equity for Income Lovers

2.7 Variations on a Theme: Product Innovations Abound

2.8 Convertible Glossary

3 The Life Cycle of Convertibles and Warrants, William T. Moore

3.1 Issuance of Warrants and Convertibles

3.2 Calling Convertibles and Warrants

3.3 When should Warrants and Convertibles be Called?

3.4 What Happens to Firm Value when Firm Force Conversion or Exercise?

3.5 Assessing the Value of the Call Provision in Theoretical Models

3.6 References

4 Derivative Data, John Poignand

4.1 Introduction

4.2 Section One: The Convertible Bond and Convertible Preferred

4.3 Section Two: Conversion and Related Data

4.4 Section Three: Calculated Data

5 The Value Line Experience with Convertibles, Lawrence Cavanagh

5.1 Value Line's Convertible Indexes and Market Profiles

5.2 The Performance of Value Line's Recommended Convertibles

5.3 Summary

5.4 Endnotes

6 Hybrid Instruments: A Tax Planning Synopsis, Linda E. Carlisle

6.1 Fundamental Economic Characteristics of the Instruments

6.2 Three Forms of Transaction

6.3 Objectives

6.4 Open Issues

6.5 Conclusions

7 Mandatory Convertible Reset Structures, Colum McCoole

7.1 Introduction

7.2 Origins of the Japanese Bank Reset Market

7.3 Glossary of Key Terms

7.4 Mechanics of the Reset

7.5 Valuing Mandatory Convertible Resets

7.6 Evolving into an Equity Proxy

7.7 Trading Behavior of Mandatory Reset Structures

7.8 Negative gamma Becoming Part of the Vocabulary

7.9 Conclusions

7.10 Appendix

8 Japanese Reset Convertible Bonds and Other Advanced Issues in Convertible Bonds, Izzy Nelken

8.1 Introduction

8.2 The Reset Feature

8.3 Modeling of Reset Convertibles

8.4 Two More Interesting Points to Related to Convertible Securities

9 A Dictionary of Terms Related to Hybrid Instruments, Gary Gastineau and Mark Kritzman

Appendix: ConvB CD ROM Installation Guide

Index Izzy Nelken is president of Super Computer Consulting, Inc. in Mundelein, Illinois. Super Computer Consulting, Inc. specializes in exotic options, convertible bonds and other complex derivatives. Izzy holds a PhD in computer science from Rutgers University and was on the faculty at the University of Toronto. In addition to his work with Super Computer Consulting, Izzy teaches numerous courses and seminars around the world on a variety of topics including: credit risk management and credit derivatives exotic options, financial engineering, volatility and correlation and hybrid securities. He is also a lecturer in the prestigious mathematics department at the University of Chicago, Izzy's seminars are known for being non-mathematical. Instead they combine cutting edge analytics with real world applications and intuitive examples. Izzy is the editor and co-author of three previous books covering exotic options, option embedded bonds and volatility in the capital markets and is also the sole author of a book on implementing credit derivatives. www.supercc.com Hybrid instruments, or convertibles, have a fascinating history. Originally created in 1881, by 1929 they made up 40% of debt issuance but during the Second World War they all but disappeared from the scene. Today - perhaps thanks to the risks of the well-publicized financial collapses seen over recent years - they have made a remarkable comeback and currently command a market of US$350 billion. Their low historical volatility and high historical returns when compared to alternative investments are a huge attraction to many investors. The secret of the success of hybrids lies in their inherent flexibility. They offer the investor the flexibility of a fixed income security combined with the opportunity to take advantage of any upside in the stock markets. This dual role therefore requires special techniques and tools in order to issue such securities successfully and also to be able to trade in them profitably and take advantage of arbitrage opportunities. The fact that these instruments are so flexible has also resulted in the spawning of a huge range of variations, with increasingly inventive names - reverse convertibles, DECS, PERQS, LYONs, ELKS, TOPrS to list only a few, Buried within each of these variations, a trader can also find a wide variety of specialist variations such as the screw clause, the negative pledge and the reset feature. Coupled to all these issues, there are also problems of valuation, tracking indexes of convertibles and the lack of significant input data with which to run models. The Handbook of Hybrid Instruments cuts a swathe through all these complexities and variations to provide an analytical and practical explanation of all the key issues surrounding convertibles from some of the world's leading experts. A general and comprehensive introduction to the topic is followed by chapters detailing the most recent developments in the market including valuation techniques, when and if a corporation should issue convertibles and the impact that may have on the stock price, the problems of input data, the analysis of convertible bond indexes, tax planning in the US using convertibles, and the issue of reset clauses. In addition, a detailed glossary of all the key terms and variations that pertain to hybrid instruments is provided. An indispensable tool to steer readers thought the complex maze of hybrid instruments!

Hybrid instruments - essentially bonds with an equity component - are found in a multitude of guises. This generic heading encompasses a seemingly endless array of financial instruments, including convertible bonds, mandatory convertibles, reverse convertibles, preferred shares, ELKS, DECS and Lyons. Within each one of these instruments are found a wide range of variations and features. These include reset, negative pledge, screw and forced conversion clauses, as well as step up coupons, call schedules, call options with soft and hard protection etc.

The range of possibilities can seem bewildering, but it is this very flexibility which proves a huge attraction for investors, issuers and financial institutions. On the sell side companies issue these securities and corporate service departments advise on the type of options to include in them. On the buy side, investment managers seek to build portfolios with limited risk exposure using these securities and hedge funds utilise arbitrage opportunities between the convertible bond and the common share.

The opportunities are endless but the seemingly labyrinthine complexities can prove daunting. The Handbook of Hybrid Instruments helps steer a clear path through the maze. Izzy Nelken has drawn together a team of experts to provide in-depth analysis of many of the key issues that both sellers and buyers require in order to operate effectively and profitably.

A general introduction is followed by specific information on key clauses and variations, valuation methods, the impact on a firm's value following the public issuance of convertibles, details on when an issuer should call a convertible and the impact of these provisions on the price, the difficult requirement of input data to make sense of the models, indexes and reset convertibles. Finally, a highly useful glossary is provided of all the key terms used in this field.

An analytical CD is also provided with the book, containing sample software of ConvB++. ConvB++ combines complex state of the art models with a simple, user friendly interface to assess fair values prices and to hedge parameters of hybrid instruments.

The Handbook of Hybrid Instruments is an indispensable explanatory and analytical tool for all professionals looking for the latest thinking on convertibles from some of the world's leading experts.