During processing, the system calculates amortization for a convertible bond bought at premium based on the Convertible Option Price Method defined for the amortization rule in effect for the lot, along with other criteria. You can choose a Convertible Option Price Method of Stated Redemption Price at Maturity (SRPM) or Embedded Equity Option Value.
About the SRPM Method
The Stated Redemption Price at Maturity (SRPM) methodology is for tax lots purchased at a premium and uses the target maturity price in the calculation of amortization yield. The SRPM is calculated as = conversion ratio x market value of underlying shares (that is, value of stock price) / 10. This amortization method takes into consideration the value of the stock as the target maturity price to calculate amortization yield. The system considers put and call dates and put and call prices along with maturity date and SRPM price in the calculation of yield according to the amortization rule elections. Puts and call logic is incorporated in the calculations of yields.
If you purchase a convertible bond at a premium and the security utilizes the SRPM method, after you click Submit, Eagle Accounting calculates the Stated Redemption Price at Maturity (that is, the market value of a share if converted to the underlying security) as part of the processing transaction. Eagle Accounting uses the Stated Redemption Price at Maturity (SRPM) as the target maturity price in the calculation of yield and amortization.
If you purchase the lot at a discount, Eagle Accounting does not calculate the Stated Redemption Price, and the SRPM is equal to the maturity price of the bond from the SMF record. Additionally, if a specific lot is bought at a premium and the calculation of SRPM is less than 100, Eagle Accounting forces the SRPM price to equal the redemption price of the security on the SMF record (in most cases this is 100). If the security has Put or Call features, and the entity recognizes calls and/or puts in the amortization rule, Eagle Accounting uses those values in the calculation of amortization yield. If the security has only Put features, Eagle Accounting amortizes to the Put Date and Price that calculates to the highest yield ("Yield to Best"); or if the security has only Call features, Eagle Accounting amortizes to the call Date and Price that calculates the worst yield ("Yield to Worst"), considered the most conservative). If a security has both Put and Call features, Eagle Accounting uses an iterative method to determine the most conservative yield. For details, see "Example: Determining Yield for a Schedule with Both Puts and Calls."
About the Embedded Equity Option Value Method
The Embedded Equity Option Value Methodology is also used for tax lots purchased at a premium. This method allows the convertible bond price to be separated from the convertible bond cost for the purposes of calculating the amortization yield. After separation of the embedded equity option value, if the resulting fixed income cost is at a discount, then discount should not be amortized if the combined amortized cost and the embedded option premium will exceed the bond's cash redemption value (that is, par in most cases). The system considers put and call dates and put and call prices along with maturity date and price in the calculation of yield according to the amortization rule elections. The following figures show shows the process by which the system calculates amortization for a convertible bond with the Embedded Equity Option Value method.
Figure 34: Convertible Bonds Workflow, Part 1
Figure 35: Convertible Bonds Workflow, Part 2
The following section shows the impact of different prices and call features on yield calculations in Eagle Accounting when you use the Embedded Equity Option Value (EEOV) convertible option price method with convertible bonds.
Maturity date = 4/15/2029
Convertible bond price/ Cost | Bond Value | EEOV | Call / Put | Amortization To and From | System Processing | |
|---|---|---|---|---|---|---|
CV purchase at premium | 110.00 | 105.00 | 5.00 | No call / put. | Amortize from 105 to 100. | Amortize premium of $5 to maturity date by amortizing cost from $110 to $105. |
110.00 | 105.00 | 5.00 | Par call resulting in worst yield. | Amortize from 105 to call date and price. | Amortize premium of $5 to call date by amortizing cost from $110 to $105 (par call price + $5 embedded equity option value). | |
110.00 | 105.00 | 5.00 | Call at 102 resulting in worst yield. | Amortize from 105 to call date and call price of 102. | Amortize premium of $3 to call date by amortizing cost from $110 to $107 (call price $102 + $5 embedded equity option value). | |
110.00 | 105.00 | 5.00 | Put at 104 resulting in best yield. | Amortize from 105 to put date and put price of 104. | Amortize premium of $1 to put date by amortizing cost from $110 to $109 (put price $104 + $5 embedded equity option value). | |
110.00 | 105.00 | 5.00 | Call and put feature - both at par.(1) Worst yield would be on call date (4/15/2020).(2) Best yield would be on maturity date. | Rule would be to use earliest of the worst call date and price or best put date and price.In this case, earliest date would be worst call date so should amortize from 105 to call date and price of 100. | Amortize premium of $5 to worst call date by amortizing cost from $110 to $105 (call price $100 + $5 embedded equity option value). | |
110.00 | 105.00 | 5.00 | Call and put feature.(1) Call at 102 on 4/15/2020 resulting in worst yield.(2) Put at 104 on 4/15/2019 resulting in best yield. | Use earliest of worst call date or best put date. Amortize from 105 to put date and price of 104. | Amortize premium of $1 to best put date by amortizing cost from $110 to $109 (put price $104 + $5 embedded equity option value). | |
110.00 | 102.00 | 8.00 | (1) Put at 104 on 4/15/2019 resulting in best yield (2) Put at 101 on 4/15/2020 resulting in second best yield. | (1) Would not amortize discount from 102 to 104 since discount on the debt instrument should not be amortized if the resulting combined amortized cost and embedded option premium would exceed the amount collectible upon cash redemption. Eagle would need to bypass the best yield in this case and do not amortize from settlement date to put date of 4/15/2019. (2) If the put option is not exercised by 4/15/2019 (best yield date), then amortize to next best yield, which would be to amortize premium from 102 to 101 to next put date of 4/15/2020. | Do not amortize discount to best put date of 4/15/2019. | |
CV purchase at premium. Clean bond value at discount. | 110.00 | 95.00 | 15.00 | With or without call / put. | Do not amortize. No amortization on discount if the resulting combined (amortized) cost of the debt instrument and embedded option premium would exceed the amount collectible upon cash redemption of bond (par in this case). | Do not amortize. |
CV purchase at par. Clean bond value at discount. | 100.00 | 95.00 | 5.00 | With or without call / put. | Do not amortize. No amortization on discount if the resulting combined (amortized) cost of the debt instrument and embedded option premium would exceed the amount collectible upon cash redemption of bond (par in this case). | Do not amortize. |
CV purchase at discount. | 90.00 | 85.00 | 5.00 | No call / put. | Amortize from 90 to 100. | Amortize discount of $10 to maturity date by amortizing cost from $90 to $100 (maturity price). |
90.00 | 85.00 | 5.00 | Have par call. Maturity date would be worst yield. | Amortize from 90 to 100 (maturity date). | Amortize discount of $10 to maturity date by amortizing cost from $90 to $100 (maturity price). | |
90.00 | 85.00 | 5.00 | Have par put. Put would be best yield. | Amortize from 90 to 100 (put date). | Amortize discount of $10 to put date by amortizing cost from $90 to $100 (put price). | |
90.00 | 85.00 | 5.00 | Call at 102. Maturity date would be worst yield. | Amortize from 90 to 100 (maturity date). | Amortize discount of $10 to maturity date by amortizing cost from $90 to $100 (maturity price). | |
90.00 | 85.00 | 5.00 | Put at 104. Put date would be best yield. | Amortize from 90 to 104 (put date and price). Resulting amortized cost, which includes the embedded option premium = 104 (cash redemption of bond on put date). | Amortize discount of $14 to put date by amortizing cost from $90 to $104 (put price). |
Processing a Convertible Bond Buy Examples
Account CBDEMO is purchasing 1,000,000 par of XYZ Corp Convertible Bond (the bond set up previously in this section), with a Trade Date of 1/16/2004 and a Settlement Date of 1/17/2004, at a Price of 165.093 (purchased at a premium). Because the target amortization price is calculated after you submit the trade, the amortization yield and trade yield displaying on the panel do not reflect the impact of underlying price or embedded equity option value entered. After the trade is processed, Eagle Accounting calculates the amortization yield utilizing the SRPM or Embedded Equity Option Value.
The following table shows the values for the sample buy in the Open Debt Bond panel.
Entity Information | |
Entity ID(1163:S) | CBDEMO2 (CBDEMO2) |
Entity Name(1164:S) | CBDEMO2 |
Base Currency(86:S) | USD |
Issue Information | |
Trade Date(35:S) | 2004 11 16 |
Accounting Date(36:S) | 2004 11 16 |
Monthly Accounting Date(4733:S) | 2004 11 16 |
Settlement Date(37:S) | 2004 11 17 |
Event Type(55:S) | BUY |
Long/Short Indicator(15:S) | L |
Cross Reference Type(1234:S) | INTERNAL |
Issue Name(961:S) | XYZ CONVERTIBLE BOND |
Ticker(13:S) | mpsxyz |
Cross Reference ID(1233:S) | XYZ CONVERTIBLE BOND (INTERNAL) (XYZ CONVERTIBLE BOND) |
Instrument Type(11:S) | FI |
Security Type(82:S) |
|
Issue Currency(85:S) | USD |
Maturity Date(38:S) | 2012 01 15 |
Coupon Rate(70:S) | 5.000000 |
Convertible Indicator(1531:S) | Y |
Accounting Information | |
Select Values to be Calculated by STAR(7000:S) | Traded Interest/Amort Yield/OID Yield/Trade Yield |
Accrued Interest Type(3715:S) | CUM |
Par Value/Current Face(40:S) | 1,000,000.000000 |
Price(45:S) | 165.09300000 |
Amort Yield(75:S) | -3.060192856634 |
Trade Yield(9430:S) | -3.060192856634 |
OID Yield(39:S) | |
Principal(165:S) | 1,650,930.000 |
Implied Commission Indicator(78:S) | NO |
Commission(47:S) | 0.00 |
Tax Amount(46:S) | 0.00 |
Stamp Duty Tax(51:S) | 0.00 |
Other Fee(3752:S) | 0.00 |
Ex Interest Processing Flag(16311:S) | N |
Traded Interest(49:S) | 16,944.440 |
Local Net Amount(50:S) | 1,667,874.440 |
Settlement Currency(63:S) | USD |
Settlement Net Amount(64:S) | 1,667,874.440 |
Local to Base FX Rate(87:S) | 1.000000000000 |
Base Net Amount(478:S) | 1,667,874.44 |
Underlying Security Market Price(319:S) | 36.750000 |
Conversion Premium(5727:S) | |
Settlement Information | |
Settle Trade Indicator(58:S) | NO |
Broker Name(1235:S) | EAGLE |
Broker Code(88:S) | EAGLE |
Example 1: SRPM with Same Asset Currency
Calculation of Stated Redemption Price and Conversion Premium for Trade Date of the purchase of a convertible bond, when the Asset Currency of the convertible bond equals the Asset Currency of the underlying security.
The Stated Redemption Price at Maturity (SRPM) is calculated using the formula:
Conversion Ratio * Market Price of Underlying Shares / 10
Note: | The reason for dividing by 10 in the prior calculation is that the Conversion Ratio is expressed in number of shares per 1,000 units of par, and the Stated Redemption Price at Maturity is expressed as a percentage. The result of the equation should be rounded to the same number of decimal places as the bond's Asset Currency. |
The Conversion Premium is calculated using the following formula:
Purchase Price of the Bond - SRMP
- The Underlying Sec Market Price is the latest available price for the underlying security in relation to the Trade Date of the Convertible Bond. It is derived from a pricing date that is less than or equal to the Trade Date.
- The results of this formula should be rounded to the same number of decimal places as the Asset Currency of the convertible bond.
To illustrate, a portfolio with a Base Currency of USD buys a convertible bond for XYZ Corp., which has XYZ Corp. Common Stock as the underlying security. Both the bond and the stock have an Asset Currency of USD. The information related to the bond's conversion feature follows in the following figure.
Figure 36: Sample Bond Conversion Feature Related Information
Example 1: Equity Option Value with Same Asset Currency
If you wanted to use the same sample data found in Example 1: SRPM to achieve the same results in Eagle Accounting, you would need to enter a conversion premium of 54.74. This allows Eagle Accounting to calculate and set a target amortization price of 154.74 ( 100 maturity price value + 54.74 Embedded Option Value ).
Example 2: SRPM where Asset Currency Differs
The calculation of the Stated Redemption Price and Conversion Premium for Trade Date of the purchase of a convertible bond, when the Asset Currency of the convertible bond does not equal the Asset Currency of the underlying security follows:
The SRPM uses the following formula in this scenario:
Conversion Ratio * Market Price of Underlying Shares / 10 / Exchange Rate
The results of this formula should be rounded to the same number of decimal places as the Asset Currency for the convertible bond. The exchange rate represented in the formula above, is the rate of the bond currency, to the rate of the underlying security currency, on the date the SRPM is calculated for.
The Conversion Premium uses the following formula:
(Purchase Price of the Bond - SRPM)
The results of this formula should be rounded to the same number of decimal places as the Asset Currency for the convertible bond.
To illustrate, a portfolio with a Base Currency of USD buys a convertible bond for XYZ Corp., which has XYZ Corp. Common Stock as the underlying security. The bond has an Asset Currency of USD, and the stock has an Asset Currency of GBP. The information related to the bond's conversion feature follows in the following figure.
Figure 37: Sample Bond Conversion Feature Related Information
Example 2: Embedded Equity Option Value where Asset Currency Differs
If you wanted to use the same sample data found in Example 2: SRPM to achieve the same results in Eagle Accounting, you would need to enter a conversion premium of 6.07. This allows Eagle Accounting to calculate and set a target amortization price of 106.07 ( 100 maturity price value + 6.07 Embedded Option Value ).
SRPM Convertible Bond Yield Calculation Examples
This section shows the impact of different prices and call features on yield calculations in Eagle Accounting when you use the SRPM convertible option price method with convertible bonds. All examples in this section use the following security master information, and assume that the Select Values to be Calculated by STAR field (tag 7000) is set to calculate Traded Interest/Amort Yield/OID Yield/Trade Yield on the Trade panel.
Security Master Information used for the examples follows.
Field Name | Value |
|---|---|
Issue Name | XYZ Convertible Bond |
Issue Description | XYZ Convertible Bond |
Primary Asset ID | XYZCB1234 |
Processing Security Type | DBIBFD |
Issue Country Code | US |
Asset Currency | USD |
Settlement Currency | USD |
Income Currency | USD |
Coupon | 5% |
Coupon Type Code | Fixed |
Day Count Basis | 30/360 |
Payment Frequency | Semi-annual |
Issue Date | 20040115 |
Dated Date | 20040115 |
First Coupon Date | 20040715 |
Last Coupon Date | 20110715 |
Maturity Date | 20120115 |
Maturity Price | 100 |
Convertible Indicator | Y |
Underlying Issue Name | XYZ Corp Equity |
Index Offset | 42.1052 |
Example 1: Convertible Bond Purchased at a Discount
Convertible XYZ Convertible Bond is bought at a Price of 99.7 and the current price of the underlying security is 24.00. Eagle Accounting only calculates a target amortization price utilizing the underlying equity price or embedded equity option value when security convertible bond is purchased at a premium.
In this example, Eagle Accounting calculates and sets a target amortization price to 100 and an Amort Yield of 5.046015424911 and amortizes to Maturity Date (1/15/2012).
Example 2: Convertible Bond Purchased at Premium with a Put Provision
XYZ Convertible Bond is bought at a Price of 101, and the current Price of the underlying security is 24.00. There is a Put provision on the bond for a price of 102 on 7/15/2006.
Calculated SRPM = 101.05 = (42.1052 * 24/10)
Eagle Accounting calculates an SRPM when the security is purchased at a premium. However, when there are call/put options, the call/put option price takes precedence over the SRPM in determining and calculating the amortization yield. Thus Eagle Accounting calculates an Amortization Yield of 5.326731234303 using the put price and date, and then amortizes out to the Put Date and Price, instead of the Maturity Date and SRPM. In the event that you do not "Put" the security on the Put Date, Eagle Accounting calculates a new yield based on existing reference data and the applicable amortization rule, and amortizes accordingly.
Note: | Eagle Accounting utilizes a Yield to Best approach when calculating a yield based on Put data. Yield to Best, as the name implies, is calculating the highest cash flow yield, or the best Put Price and Date information, that includes the Maturity Date. |
Example 3: Convertible Bond Purchased at Premium with a Call Provision
XYZ Convertible Bond is bought at a Price of 106, and the current Price of the underlying security is 25.00. There is a Call provision on the bond for a price of 102.0. The entity recognizes call data as part of the amortization calculation.
Calculated SRPM = 105.26 = (42.1052 * 25 / 10)
Eagle Accounting calculates an SRPM when the security is purchased at a premium. However, when there are call/put options, the call/put option data takes precedence over the SRPM in determining and calculating the amortization yield. Thus, Eagle Accounting calculates an amortization yield using the call price and date, and then amortizes out to the call date and price, instead of the Maturity Date and SRPM.
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