Structured note markets are replete with stories of being burnt by investing in Reverse Convertibles. SLCG has an article on apple based reverse convertibles
Investors are being told clearly understand the risks of investing in the reverse convertibles. Despite so much of hoopla around these notes, we see issuers not stopping from any further issuance of these notes. This vindicates the fact that there is clear appetite for these notes among investors. Below is an analysis of a reverse convertible issued on Facebook.
Reverse Convertible Securities on Facebook, Inc. Common Stock due April 1, 2014,
This was priced by the Royal Bank of Canada or RBC on Sept 27, 2013 at $10 per security with a total price to public of $5,169,640. The note is based on Facebook, a worldwide social networking company with a memorable IPO. On the day of pricing for this Reverse Convertible the stock was valued at $51.24 with a market cap of $121.16 Billion. A company that gets average individual investors excited about for its growth. The cause of the potential is the amount of members since it launched in the early parts of 2004 as well the recent spread of internet access through mobile devices for new members. Average investors can replicate this type of security by going, on a time scale of six months, long a bond with better coupon yield than the dividend yield of Facebook shares while shorting a down and in put option and tying those two assets together by investing in a zero coupon bond to discount the cash flows to the present day. All that at $10.00 to replicate a single Reverse Convertible note. Or purchase this security to get the benefits, at a low cost, without the hassle.
RBC is compensating for the risk by giving a coupon payment. The risk is that there is no guarantee the principal invested will return because of the dependency on the relationship of Facebook shares to the barrier level. Meaning investors could lose the entire investment. Because the credit risk of this security is based on RBC while the market risk belongs to Facebook.
On the up side the RBC decided to compensate for the risk involved in this security by giving a coupon rate of 13.20% per annum. This turns out to be $0.11 per month or on a 30/360 basis. The payoff is derived by a barrier lever to 80% of the underlying stock value on the note’s pricing date. In this case it would be $40.99 out of $51.24.
The result is if Facebook is valued at equal to or greater than the downside threshold level the stated principle plus the final coupon payment is received. On the other hand if it is below the threshold level than either a number of shares for Facebook are received in exchange or the cash value of the shares is received together with the final coupon payment. The final price on maturity is based on volatility and risk. It is important to notice that any value below the $44.84 mark is correlated with a steep drop in returns. It is also important to notice that any value at or above the same mark will only see a flat return of $10.66.
Contributed by Karthik Misra at Gatick Financial services
This was priced by the Royal Bank of Canada or RBC on Sept 27, 2013 at $10 per security with a total price to public of $5,169,640. The note is based on Facebook, a worldwide social networking company with a memorable IPO. On the day of pricing for this Reverse Convertible the stock was valued at $51.24 with a market cap of $121.16 Billion. A company that gets average individual investors excited about for its growth. The cause of the potential is the amount of members since it launched in the early parts of 2004 as well the recent spread of internet access through mobile devices for new members. Average investors can replicate this type of security by going, on a time scale of six months, long a bond with better coupon yield than the dividend yield of Facebook shares while shorting a down and in put option and tying those two assets together by investing in a zero coupon bond to discount the cash flows to the present day. All that at $10.00 to replicate a single Reverse Convertible note. Or purchase this security to get the benefits, at a low cost, without the hassle.
RBC is compensating for the risk by giving a coupon payment. The risk is that there is no guarantee the principal invested will return because of the dependency on the relationship of Facebook shares to the barrier level. Meaning investors could lose the entire investment. Because the credit risk of this security is based on RBC while the market risk belongs to Facebook.
On the up side the RBC decided to compensate for the risk involved in this security by giving a coupon rate of 13.20% per annum. This turns out to be $0.11 per month or on a 30/360 basis. The payoff is derived by a barrier lever to 80% of the underlying stock value on the note’s pricing date. In this case it would be $40.99 out of $51.24.
The result is if Facebook is valued at equal to or greater than the downside threshold level the stated principle plus the final coupon payment is received. On the other hand if it is below the threshold level than either a number of shares for Facebook are received in exchange or the cash value of the shares is received together with the final coupon payment. The final price on maturity is based on volatility and risk. It is important to notice that any value below the $44.84 mark is correlated with a steep drop in returns. It is also important to notice that any value at or above the same mark will only see a flat return of $10.66.
Hypothetical underlying
stock closing price on
valuation date
|
Value of total
payment per
RevCons
|
Total return on
the RevCons
|
$0.00
|
$0.66
|
-93.40%
|
$12.81
|
$3.16
|
-68.40%
|
$32.03
|
$6.91
|
-30.90%
|
$40.95
|
$8.65
|
-13.50%
|
$44.84
|
$10.66
|
6.60%
|
$51.24
|
$10.66
|
6.60%
|
$70.46
|
$10.66
|
6.60%
|
$89.67
|
$10.66
|
6.60%
|
Contributed by Karthik Misra at Gatick Financial services
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