Reverse Convertible

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A Aktienanleihe (also share tender bond , English reverse convertible bond or equity linked bond ) is a structured product . Their most important feature is that at the end of the term , the issuer has the right to either repay 100% of the nominal amount or to deliver a certain number of (previously determined) shares . In addition, the investor receives one or more coupon payments during the term. The coupon is usually significantly higher than that of a conventional bond .

If the base value is a share, one speaks of a reverse convertible bond . If the repayment depends on the development of an index (e.g. the DAX ), it is an index bond .

From the issuer's point of view, reverse convertibles are instruments for raising capital and at the same time for hedging prices, for the investor they are investments with high interest rates and with a high risk of loss.

Construction and functioning of a reverse convertible bond

In the case of a reverse convertible, the investor acquires a fixed-income security with a fixed nominal amount. The purchase price is derived from “number of bonds purchased × nominal amount × current bond price in percent”. In addition, the purchaser will be charged any accrued interest since the issue date or the last interest date . Like standard bonds, reverse convertibles come with a coupon , but the interest rate is usually well above their level.

What is special about the reverse convertible bond is that at the end of the term, the issuer has the option to either repay the nominal amount or to offer the investor a predetermined number (referred to as the subscription amount or ratio) of certain shares. The type of repayment is determined by the price of the underlying security on the valuation date (shortly before the end of the term) - compared to the agreed base price, also known as the exercise price , tender threshold or " strike ": If the share price is below the fixed base price, the issuer regularly assigns shares; in the opposite case, the nominal amount is paid.

Example: The buyer of the reverse convertible purchases a reverse convertible bond from the issuer (a bank) for € 1,000 on December 31, 2000 with Allianz AG shares (WKN 840400) as the underlying . A coupon of 12% p. a. paid, which the investor receives in any case. The issuer reserves the right to redeem on December 31, 2002 either by paying the nominal amount (= € 1,000) or by tendering 11 Allianz AG shares. The issuer will only make use of the second alternative if the share price on the reporting date is lower than the strike price, in this case € 90.91 (= 1,000/11). Otherwise, he redeems the nominal amount.

In the case of a reverse convertible bond, the investor invests in a certificate and actually becomes the writer (also known as the “seller”) of a put option (= put). As the issuer of the bond, the bank pays interest on the purchase price paid and acquires the right to exercise the put option (on the underlying shares) on the maturity date at the agreed exercise price. The difference between the normal market interest rate and the (higher) interest rate on the reverse convertible bond is the option premium for the writer.

Constellations when due

Constellations at the maturity of a reverse convertible bond

The base price of the reverse convertible and the share price on the valuation date determine the form of repayment at the end of the term:

  • If the share price is below the base price, the bond issuer (as the purchaser of the put option) will exercise the option and tender the specified number of shares to the writer (i.e. the buyer of the reverse convertible bond). Since only whole pieces can be delivered, the bond holder will be paid a pro rata cash settlement (also called "cash settlement") in the event of any ratio decimal places when due.
  • If the share price is at or above the strike price, the bond issuer will not exercise the put option; the buyer of the reverse convertible will receive the nominal amount of the bond back.

In both cases, the buyer of the reverse convertible receives the interest including the option premium contained therein. The bond can also be sold before the due date and at the then valid bond price, with the seller being credited with the proportional interest for the period up to the sale.

When issuing the reverse convertible bond, the issuing bank often chooses the strike price close to the current price of the underlying share, so that the reverse convertible bond is quoted at 100%. During the term, their price is primarily based on the price of the base share , its course and volatility : Share prices below the base price reflect their movement roughly proportionally in the price of the bond, with u. U. considerable price losses. On the other hand, at share prices above the base price, the bond will only achieve prices above 100% due to the higher yield (compared to the general interest rate) and will approach 100% by the time of maturity.

A realization loss due to the delivery of shares with a lower value (than the cost price) arises for the bond arithmetically exactly on the due date - assuming that the delivered shares are sold immediately. By holding the shares until a price recovery (expected) occurs later, a loss can subsequently be reduced (through full or partitioned sale) or even become a profit. This is also treated in this way for tax purposes ( final withholding tax ). A price risk arises again for the extended holding period .

Calculating the success

From a return point of view, success for the investor results from the following components, marked with plus (+) or minus (-) :

  1. (-) Purchase price of the bond: Depending on the current share price and the base price, it can be well below 100 percent of the nominal value.
  2. (+) Interest income : Interest is paid in all cases and accrues to the investor from the time of purchase, possibly after payment of accrued interest (-) until the sale or until the due date.
  3. (+) Selling price of the bond: If the bond is sold early.
  4. (+) Nominal amount : When the bond is redeemed (if the price of the underlying security is higher than the strike price).
  5. (+) Market value of tendered shares: When the shares are tendered on the due date. The value of the shares at maturity is to be interpreted as the redemption amount instead of the nominal amount. It is always lower than the nominal amount and can be close to zero in the event of extreme price falls. Any cash compensation paid for portions that cannot be delivered is also included in the proceeds.
  6. (+) If one extends the return analysis beyond the maturity date of the bond, a later market value or sales proceeds of the shares received can represent the market value according to 5 can be viewed as a return component.
  7. (-) All fees paid (for purchase, sale, maturity etc.) are relevant in terms of both tax and return considerations.
  8. (+/-) Accruing taxes ( final withholding tax from the transactions made (2,3,4,6) are to be taken into account in accordance with the individual tax status ( income tax ) of the investor (tax exemption, etc.).

Other forms of reverse convertible bonds

In addition to the standard form, there are other types of reverse convertible on the market. The following descriptions are only guidelines that may be defined differently by the issuer in specific cases:

  • Index bond: The principle is the same as for a reverse convertible bond. If the price of the underlying index is below the base price, the redemption is usually made in cash, with some issues exceptionally by means of an index security.
  • Reverse Convertible Plus / Reverse Convertible Protect: Here, in addition to the base price, a 'barrier price' is agreed, the undershooting or undershooting of which during the term determines the form of repayment of the reverse convertible when due: nominal or shares, e.g. Partly independent of the then current share price.
  • Multi-Reverse Convertible: The underlying is multiple stocks - with different base prices. The form of repayment is based e.g. B. on the stock with the worst price development.
  • Protect Multi Reverse Convertible: Here, too, several stocks are used as underlying assets. In addition, thresholds are defined, the undershooting or exceeding of which (for one or all shares) determines the form of repayment.

Tax treatment

Reverse convertible bonds are no longer at a disadvantage in Germany since the withholding tax was introduced compared with the structurally similar discount certificates.

The following rules apply to reverse convertible bonds acquired after 2008 (special rules apply to old stocks):

  • Purchase of the bond: Possibly. Accrued interest paid is tax-relevant, d. H. the resulting withholding tax will be reimbursed or offset against later tax amounts.
  • Selling before the due date: Succeeding in the sale = price success (difference between the price of the reverse convertible bond when buying and selling) + interest ./. accrued interest paid ./. fees paid. Profit is taxable, loss can be offset against all income subject to withholding tax.
  • Maturity (with nominal repayment): Interest and any exchange gains (./. Fees) are subject to withholding tax; Exchange rate losses can be offset against all income subject to withholding tax.
  • Maturity (with stock tender): The interest and any cash compensation that may arise are investment income subject to withholding tax. The purchase price of the bond (./. Fees) is the purchase price of the shares actually received (without cash compensation), from which the tax-relevant result only results when the bond is later sold (./. Sales fees): profits are then taxable, losses are only can be offset against profits from stock transactions. Avoidance strategy: sell the bond shortly before maturity.

Risks compared to investing in the underlying

When weighing up the investment directly in the underlying asset (i.e. directly in the share in the case of a reverse convertible bond) and in the reverse convertible bond, the following risk structure applies:

  • The interest is always paid regardless of the redemption of the reverse convertible. Viewed in this way, a total loss (apart from the issuer risk, see below) is not possible (this is also one of the reasons why a reverse convertible is classified as a financial innovation). Nevertheless, the investor must be aware that he is basically almost in full stock market risk.
  • If the price of the underlying asset rises particularly sharply (i.e. higher than the exercise price plus coupon), the investor misses out on price gains and any dividend payments that he / she could have realized with a direct investment in the underlying asset.
  • If the share price falls during the term, the price of the bond can drop disproportionately. If the bond is sold before the maturity date, there will then be a higher capital loss, possibly reduced by accrued interest.
  • A reverse convertible bond is a bond for which there is a promise to pay interest, but no promise to repay the nominal value. It bears an issuer risk : if the issuing bank should become insolvent, the repayment and outstanding interest payments on the reverse convertible bond are no longer secure.

When should you buy a reverse convertible?

The risk of a reverse convertible bond is only slightly lower than that of a direct investment in the underlying. The investor participates almost completely in losses, but only to a limited extent in profits, because the profit is “capped”. It is therefore advisable to purchase these products only in expectation of moderately increasing or constant prices. The much higher interest rate (coupon) is, however, a risk buffer for losses from a negative price development of the share, which is why reverse convertibles are often compared with discount certificates.

Since profits and losses essentially result from the development of the underlying asset, it is extremely important to obtain thorough information on the underlying asset.

literature

  • Rolf Beike: Stock bonds. An introduction to structured financial products . Schäffer-Poeschel Verlag, 2000, ISBN 3-7910-1644-X .
  • Wolfgang Gerhardt: Reverse Convertible Bonds . In: Gert Moritz (Ed.): Handbook of financial and asset advice . Wiesbaden 2004, p. 109-128 .
  • Hendrik Scholz, Marco Wilkens: Reverse Convertibles and Discount Certificates - Valuation, Pricing Risk and Implied Volatility . In: Finance Operations . No. 3/2000 , p. 171-179 .

Individual evidence

  1. ↑ BMF individual questions on the flat tax of December 22, 2009