Types of Structures
A reverse convertible is issued as either a Basic or Knock-In structure. In both cases, the investor will receive the stated coupon during the holding period. At maturity, the investor receives either 100% of their original investment, or a predetermined number of shares of the underlying stock determined as follows.
Predetermined Number of Shares
The number of shares is determined by dividing the original investment amount by the initial price of the underlying stock.
For example: A $10,000 original investment that has a $10 initial price equals 1,000 shares.
Basic Structure
An "initial price" is determined at issuance. If, at maturity, the stock price closes at or above the initial price, the investor will receive 100% of their original investment amount plus the stated coupon.
If, at maturity, the closing stock price is below the initial price, the investor will receive a predetermined number of shares of the underlying stock. Because the closing price is below the initial price, the shares' value will be less than the investor's original investment amount. As always, the investor still receives the stated coupon.
Knock-In Structure
Like the basic structure, the investor will receive either 100% of the original investment amount or shares of the underlying stock at maturity, but the knock-in feature offers the investor a certain amount of downside protection. As always, the investor receives the stated coupon during the holding period of a knock-in reverse convertible.
For the examples below, let's assume the following:
- Original Investment Amount = $10,000
- Initial Price = $10.00
- Knock-in Level = $7.00 (70% of the initial price)
- Investor Receives Cash at Maturity (2 scenarios):
- The stock closes at or above the $10.00 initial price, regardless of whether the stock price closed below the $7.00 knock-in level during the life of the investment.
- The stock closes below the $10.00 initial price, but has never closed at or below the $7.00 knock-in level.
- Investor Receives Stock at Maturity (1 scenario):
- The stock closes below the $10.00 initial price and also closed at or below the $7.00 knock-in level at any time during the life of the investment. In this scenario, the investor will receive 1,000 shares of stock. The value of the shares is based on the closing price of the stock, and will be less than the $10,000 original investment amount.
