/
Convertible Bonds Best Practices

Convertible Bonds Best Practices

Owned by Jawann Swislow
Last updated: yesterday at 8:08 pm by Jawann Swislow
4 min read

Overview

This document applies to all releases of Eagle software.

Convertible Bonds are fixed income securities that can be converted into a specific number of common or preferred shares at a future date. Because of this feature, Convertible Bonds trade with slightly lower interest rates than vanilla corporate bonds. The number of shares that can be converted from each bond is determined by conversion ratio, which is specified in the bond's reference data.

Convertible Notes related to early stage startup and venture capital investing are also modeled as Convertible Bonds in Eagle. The key differences are that interest is only paid at maturity or conversion (typically in preferred stock) and the exact details of the post-conversion security are unknown.

Refer to attached  spreadsheet for example calculations, security setup, trade, and conversion.

Entity Setup

There is no special entity setup required for Convertible Bond trading.

Reference Data

Security Data

In addition to the common coupon and date fields required by all fixed income securities, Convertible Bonds require the following setup defined below.

  • Processing Security Type (3931) = DBIBFD (Interest Bearing Debt Instrument)

  • Convertible Indicator (1531) = Yes

  • Underlying Security ID (1348): enter the Primary Asset ID (14) of the post-conversion security

  • Index Offset (215): enter the conversion ratio if known

Floating rate Convertible Bonds are not currently supported because the Underlying Security fields need to reference the "to security" rather than the floating rate index. These should be set up as variable rate instead.

Convertible Notes

  • Payment Frequency (472) = MAT (At Maturity)

  • Underlying Security ID (1348): enter the Primary Asset ID (14) a placeholder security

    • This can be updated or changed later

  • Index Offset (215): enter the ownership percentage

  • Amount Issued (1537) and Amount Outstanding (1543) can be used to capture the discount and valuation cap

Alternatively and with small configuration changes, user-defined fields can be used to capture the ownership percentage, discount, and valuation cap.

Stated Redemption Price at Maturity with Foreign Security

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. If a Convertible Bond's Asset Currency (85) is different than the base currency of an entity, the SRPM should be calculated as follows:

  • SRPM = Conversion Ratio * Market Price of Underlying Shares / 10 / Exchange Rate

There is currently an issue with calculating SRPM for foreign assets. Accounting is multiplying instead of dividing by the exchange rate, which results in incorrect SRPM and thus inaccurate amortization. This issue is tracked as Bugtracker # 117599.

Example

Assume a Convertible Bond has a conversion ratio of 42.11, current market price of the underlying shares is $36.75, and exchange rate is 0.96227982. The correct SRPM would be calculated as:

  • SRPM = 42.11 * 36.75 / 10 / 0.96227982 = 160.80

Instead, Accounting calculates as:

  • SRPM = 42.11 * 36.75 / 10 * 0.96227982 = 148.90

Incorrect SRPM

Workaround

First, the correct SRPM needs to be calculated using the formula specified above. Then, calculate an adjusted conversion ratio (entered as Index Offset on the security master) using this formula:

  • Adjusted Conversion Ratio = SRPM / Market Price of Underlying Shares * 10 / Exchange Rate

For this example Index Offset is changed to the calculated value of 160.80 / 36.75 * 10 / 0.96227982 = 45.47. This results in correct the SRPM value and resulting amortization.

Correct SRPM

Trade Processing

If any trades were booked against the Convertible Bond with the stated conversion ratio (Index Offset) they will have to be canceled. Once they are canceled the security master can be amended and then the trades can be rebooked.

Conversion

Convertible Bonds are converted into their underlying using the Create Exchange Offers corporate action. Announcements are set up using Reference Data Center.

  • From Asset ID (14): enter the Primary Asset ID of the Convertible Bond

  • From Post Action Price (369): market price of the Convertible Bond on the day of conversion

  • Sweep Date (1197): date when the global corporate action process will pick and execute the corporate action (generally current date)

  • Ex Date (65): date when the corporate action takes effect (conversion date)

  • Corporate Action Status (54) = Released

  • Mandatory/Voluntary Indicator (1734) = Mandatory

  • To Asset ID (1348): Primary Asset ID of underlying security

  • To Post Action Price (319): market/agreed price of underlying equity on the day of conversion

  • Rate of Action (1001): enter conversion ratio specified in Convertible Bond's reference data, not calculated value (the calculated value entered on the security master is only needed for accurate SRPM and amortization)

    • For Convertible Notes, enter the ratio that results in the correct number of shares

  • Corporate Action Type (1728) = Exchange Offer

To process the corporate action, use Accounting Center > Processing and Exceptions > Global Processes > Corporate Actions > Exchange Offer (V17+) or Global Process Center > Corporate Actions Processing > Exchange Offer/Assimilation/Unit Splits (pre-V17). Query for the Convertible Bond, set Corporate Action Begin Sweep Date (220) and End Sweep Date (221) to a range that includes Sweep Date from Exchange Offers panel, and submit.