Post-liquidation processing of a standard mutual fund return involves the calculation of the gain or loss for each set of shares 'bought' during the performance period. The standard calculation of the gain/loss can be stated as:
Proceeds - Cost = Gain/Loss where
Proceeds = Shares Bought * Sell Price
Cost = Shares Bought * Buy Price
This formula is not sufficient in cases when performing a convertible, post-liquidation return because:
- The pre-conversion shares have a cost based on the shares and buy price of the convert from fund, but,
- The proceeds are based on the sell price of the convert to fund.
During the post-liquidation process for calculating PROCEEDS for pre-conversion shares, you multiply the share balance by a conversion ratio.
The conversion ratio represents the ratio of the sell price of the convert from fund to the buy price of the convert to fund on the conversion date.
This ratio, when applied to pre-conversion shares, has the effect of putting the proceeds for those shares in terms of the convert to fund.
Conversion Ratio: (Sell Price [convert from] / Buy Price [convert to])
This process is shown below in the following figure.
Based on this example, you can see that there are 2 lots of pre-conversion shares based on the convert from NAV stream (which is around $10):
- 100 shares bought at $10
- .6863 shares bought at $10.20
The issue is that on conversion date everything is put into terms of the convert to fund which has a NAV around $50. If you apply the standard formula for proceeds (shrs x sell price), you multiply 100 shares x $50 and derive proceeds of $5000. By adjusting the pre-conversion shares (100 * .221739), Eagle effectively adjusts the share balance to be in terms of the convert from fund.
22.173 shrs x $50 sell price = $1108.70 proceeds
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