Exchangeable bond
Encyclopedia
Exchangeable bond is a type of hybrid security
consisting of a straight bond
and an embedded option
to exchange the bond for the stock
of a company other than the issuer (usually a subsidiary
or company in which the issuer owns a stake) at some future date and under prescribed conditions. An exchangeable bond is different from a convertible bond
. A convertible bond gives the holder the option to convert bond into shares of the issuer.
The pricing of an exchangeable bond is similar to that of convertible bond, splitting it in straight debt part and an embedded option part and valuing the two separately.
Hybrid security
Hybrid securities are a broad group of securities that combine the elements of the two broader groups of securities, debt and equity.Hybrid securities pay a predictable rate of return or dividend until a certain date, at which point the holder has a number of options including converting the...
consisting of a straight bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
and an embedded option
Embedded option
An Embedded option is a component of a financial bond or other security, and usually provides the bondholder or the issuer the right to take some action against the other party. There are several types of options that can be embedded into a bond. Some common types of bonds with embedded options...
to exchange the bond for the stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
of a company other than the issuer (usually a subsidiary
Subsidiary
A subsidiary company, subsidiary, or daughter company is a company that is completely or partly owned and wholly controlled by another company that owns more than half of the subsidiary's stock. The subsidiary can be a company, corporation, or limited liability company. In some cases it is a...
or company in which the issuer owns a stake) at some future date and under prescribed conditions. An exchangeable bond is different from a convertible bond
Convertible bond
In finance, a convertible note is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price. It is a hybrid security with debt- and equity-like features...
. A convertible bond gives the holder the option to convert bond into shares of the issuer.
The pricing of an exchangeable bond is similar to that of convertible bond, splitting it in straight debt part and an embedded option part and valuing the two separately.
Pricing
Price of exchangeable bond = price of straight bond + price of option to exchange- Price of an exchangeable bond is always higher than the price of a straight bond because the option to exchange adds value to an investor.
- Yield on an exchangeable bond is lower than the yield on a straight bond.