analyzing-convertible-bonds

name	analyzing-convertible-bonds
description	Evaluates convertible bond structures with equity sensitivity, credit floor, and Greeks calculation. Use when analyzing convertibles, calculating conversion premiums, or evaluating hybrid instruments.
tags	["analysis","fixed-income","credit"]
metadata	{"author":"casemark","practice_areas":["Fixed Income","Credit Research","Bond Trading"],"document_types":["Analysis Report"],"skill_modes":["Analysis"]}

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

1. 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]

2. 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

3. 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

4. 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]

5. 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

6. Run scenario analysis

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