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KYNEX Bulletin September 2005 |
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In this issue we discuss a few refinements to our Convertible Calculator. Visit us on the web:E-Mail your suggestions and comments to: Copyright © 1996 - 2004 |
- Contingent Conversion is not disabled on the maturity date. - Business day adjustments for floating rate convertibles are now being enforced for coupon dates as well as call and put dates. - Provisional call trigger days are now an available override to provide flexibility. - Cash call parity override behavior has been refined. - Perpetual convertibles’ terminal date is forced to be on the payment cycle. - Convertible securities with forward first settlement dates are now valued using the first settlement date. - Call notice days and exercise schedule are now synced to ensure the use of correct conversion ratio in the model |
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Contingent Conversion
Up until now, our model disabled the contingent convertibility, if the convertible security is called for redemption prior to the final maturity date as well as on the final maturity date. Based on feedback from clients as well as our review of indentures we have refined the rules for disabling the contingent convertibility. The new version will not disable the contingent convertibility on the final maturity date. This means, if the convertible security survives until the final redemption date, the model now enforces a dead zone which affects the holder of the convertible security in an adverse manner. The impact of this change is negligible on convertible securities that are callable prior to the maturity date as valuation is dominated by the early call date. Convertible securities that are not callable for life (NCL) and have contingent conversion features are affected by this change.
Floating Rate Convertible Securities
Up until now, we have modeled the cash flows of floating rate convertible securities with no business day adjustments, which is typical of fixed coupon paying corporate bonds. In the market however, the payment dates and reset dates are being subject to business day adjustments for floating rate convertible securities. Our new version incorporates the business day adjustments for the coupon dates, call dates and put dates.
Provisional Call Trigger Days
Convertible securities that are provisionally callable usually require the stock price to be above the trigger price for a pre-set number of days (x) out of yet another pre-set number of days (y), such as 20 out of 30, 15 out of 20, etc. The pre-set days are stipulated in the indenture. The Kynex calculator performs a subsidiary calculation inside the finite difference grid to come up with an “effective knock-out trigger” which is slightly greater than the trigger and is a function of volatility. The idea is for a given volatility the stock has to reach the effective trigger on average in order to stay above the trigger for x out of y days. We have validated our results against a Monte Carlo simulation and believe that our methodology is a correct way of valuing provisionally callable convertible securities.
We also believe the market participants need some flexibility in overriding the effective trigger calculated internally. The new version provides an override for the number x in the x-out of-y specification. On our convertible details page, you will see a new input box in the Advanced Model Inputs section labeled Trg Days. Inputting 1 in this box will make the effective trigger same as the trigger. You can also choose to input a number between 1 and the number of days specified in the prospectus and let our model come up with an appropriate effective trigger. Alternatively, you can input 1 in the Trg Days and specify a call adjustment to capture your perspective of the provisional call.
You can also keep a custom default at the desk-level as well as at security level for the provisional call trigger days.
Cash Call Parity
This is an available override in the advanced model inputs section. Up until now, entering 85 in this box was being interpreted as “the issuer MAY call if parity is below 85”. The new version implements the boundary condition as “the issuer WILL call if parity is below 85”. The effect of this is visible, if you try to impose a parity floor and a parity cap for the survivability of the convertible security via Call Adjustment specification and the Cash Call Parity specification. For example, if you specify a call adjustment of parity+ 15% and a cash call parity of 90, the security will be modeled as callable for force conversion if parity is above 15% of call price and callable for cash if parity is below 90.
Perpetual Convertible Securities
The Kynex convertible calculator values perpetual convertible securities by imposing a terminal date that is 30 years out with a redemption value of 0.001. Up until now, the 30 years was calculated from the valuation date regardless of the coupon payment cycle. The new version calculates the terminal date to be 30 years from the next coupon payment date, i.e. no odd-last coupons.
Forward First Settlement Dates
Convertible securities with stated first settlement dates in the future were being valued with current valuation dates. The new version will value such convertible securities by forcing the valuation date to be the first settlement date.
Call notice days and exercise schedule
For convertible securities with discrete exercise windows (very few in our universe) there is a slight disconnect between the applicable conversion ratio and what is used in the grid during the call notice period. This has been corrected in the new version.