4. A presentation by TY ‘Da Vinci’ Thong Fund...
FNCE204: Analysis of Fixed Income
Prepared for Prof Thong Tiong Yang
Chris Tan Kok Yong | Kumara Velan S/O Suppiah | Kwok Kin Fei | Leonardi Susanny
Sunday, July 11, 2010
6. WHAT’S THE
AGENDA?
The ‘Da Vinci’ Code
Risks Exposure
Convertible Debt
Arbitrage Techniques
Introduction to
Convertible Bonds
Sunday, July 11, 2010
7. Convertible Bonds
INTRODUCTION TO
CONVERTIBLE BONDS
Sunday, July 11, 2010
8. Convertible Bonds
INTRODUCTION TO
CONVERTIBLE BONDS
A type of bond that allows
holder to convert into shares at
conversion price
Sunday, July 11, 2010
9. Convertible Bonds
INTRODUCTION TO
CONVERTIBLE BONDS
In the money
At the money
3 outcomes of a
convertible bond
Out of the money
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11. Convertible Bonds
WHY ISSUE
CONVERTIBLE BONDS?
1 2
Minimize negative Lower fixed-rate
investor interpretation borrowing costs
3 4
Less equity dilution Increase total level
compared to rights issue of debt-gearing
Sunday, July 11, 2010
12. Convertible Bonds
INTRO TO CONVERTIBLE
DEBT ARBITRAGE
Sunday, July 11, 2010
13. Convertible Bonds
INTRO TO CONVERTIBLE
DEBT ARBITRAGE
Exploit mispricing in convertible bonds (CB)
21 French CBs were underpriced by 3%
103 US listed CBs were undervalued by 4%
Sunday, July 11, 2010
14. Convertible Bonds
INTRO TO CONVERTIBLE
DEBT ARBITRAGE
Exploit mispricing in convertible bonds (CB)
A result from the difficulty in valuing option
To price attractively to ensure demand
Sunday, July 11, 2010
16. Convertible Bonds
NUMERICAL EXAMPLE
5% Coupon Rate, Annually
1 year maturity
Convertible Ratio of 50 ABC shares ($20)
Short 25 ABC shares
Share Price Unchanged Share Price Rise to $30 Share Price Drop to $10
Profit from Conversion $0 $500 $0
Profit/Loss from Short Sale $0 -$250 $250
Coupon Received $50 $50 $50
2% Interest from Short Sale $10 $10 $10
1% Interest to Broker -$5 -$5 -$5
Profit $55 $305 $305
% return 5.5% 30.5% 30.5%
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19. Arbitrage Techniques
DELTA NEUTRAL HEDGE
Long Convertible Bond
Short Underlying Stock at current Delta
CV
Delta ( ) =
S
Sunday, July 11, 2010
20. Arbitrage Techniques
DELTA NEUTRAL HEDGE
Long Convertible Bond
Short Underlying Stock at current Delta
CV
Delta ( ) =
S
Yield no profit or loss from stock price movement
Capture cash flows from coupon and interest
Sunday, July 11, 2010
22. Delta Neutral Hedge
BEGINNING POSITION
Position Quantity Price Value Profit / Loss
Convertible Long
1000 1000 $1,000,000
Position
Short Stock
16000 40 -$640,000
Position
Stock Price Moves
1%
Convertible Long
1000 1006.4 $1,006,400 $6,400
Position
Short Stock
16000 40.4 -$646,400 -$6,400
Position
Delta = 0.64 Net Profit / Loss $-
Sunday, July 11, 2010
23. Delta Neutral Hedge
CHANGE IN DELTA
AS STOCK PRICE CHANGES
Sunday, July 11, 2010
24. Delta Neutral Hedge
CHANGE IN DELTA
AS STOCK PRICE CHANGES
Position Quantity Price Value Profit / Loss
Convertible Long
1000 1006.4 $1,006,400
Position
Short Stock
16000 40.4 -$646,400
Position
Stock Price Moves
another 1%
Convertible Long
1000 1012.89 $1,012,890 $6,490
Position
Short Stock
16000 40.8 -$652,800 -$6,400
Position
Delta = 0.651 Net Profit / Loss $90
Sunday, July 11, 2010
26. Delta Neutral Hedge
RE-BALANCING
REQUIRED
Position Quantity Price Value Profit / Loss
Convertible Long
1000 1006.4 $1,006,400
Position
Short Stock
16225 40.4 -$655,490
Position
Stock Price Moves
1%
Convertible Long
1000 1012.89 $1,012,890 $6,490
Position
Short Stock
16225 40.8 -$661,980 -$6,490
Position
Delta = 0.651 Net Profit / Loss $-
Sunday, July 11, 2010
28. Arbitrage Techniques
GAMMA-CAPTURE
HEDGE
Long Convertible Bond
Same as Delta Hedge
Short Underlying Stock at current Delta
Sunday, July 11, 2010
29. Arbitrage Techniques
GAMMA-CAPTURE
HEDGE
Long Convertible Bond
Same as Delta Hedge
Short Underlying Stock at current Delta
However
Hedging ratio is different in order to Sacrifice some cash flow for
capture Gamma greater capital gain
2
CV
Gamma ( ) = 2
S
Sunday, July 11, 2010
30. Gamma Capture Hedge
BULLISH-GAMMA
CAPTURE HEDGE
Quantity Price Value
Convertible Long Position 100 950 $95,000
Short Stock Position -700 53 -$37,100
Downside Target Price Current Price Upside Current Price
Stock Price $35.50 $53.00 $79.05
Convertible Price $830.00 $950.00 $1,192.50
Delta 0.3 0.54 0.75
P/L Convertible -$12,000.00 $- $24,250.00
P/L Stock $12,250.00 $- -$18,235.00
Coupons $4,250.00 $4,250.00 $4,250.00
Stock Dividends $- $- $-
Short Credit Interest $1,394.00 $1,669.50 $2,080.00
Total P/L $5,894.00 $5,919.50 $12,345.00
12 month ROI 6.20% 6.23% 12.99%
Sunday, July 11, 2010
46. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
Sunday, July 11, 2010
47. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
current income of delta neutral position
financing cost of delta neutral position
Carryt
Sunday, July 11, 2010
48. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
(Bt*Cyt)+(deltat*Bt*OBRt- s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt)
current income of delta neutral position financing cost of delta neutral position
Sunday, July 11, 2010
49. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
(Bt*Cyt)+(deltat*Bt*OBRt - s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt)
Sunday, July 11, 2010
50. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
Capital base
required to
Current yield of Short financing establish position
bond at time t charge
(Bt*Cyt)+(deltat*Bt*OBRt - s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt)
Price of convertible Overnight Dividend
bond at time t bank rate compensation paid Leverage rate
to stock lender as
percentage of Bt
Sunday, July 11, 2010
51. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
Sunday, July 11, 2010
52. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
::Condition for starting the carry strategy::
Cyt + deltat*OBRt - s – dyt) – ((OBRt – Lt)*(Capt/Bt) + Lt) > 0
Sunday, July 11, 2010
53. The ‘Da Vinci’ Code
POSITIVE CARRY
MODEL
::Condition for starting the carry strategy::
Cyt + deltat*OBRt - s – dyt) – ((OBRt – Lt)*(Capt/Bt) + Lt) > 0
Position is held until this
condition is rendered
void!
Sunday, July 11, 2010
54. The ‘Da Vinci’ Code
CALCULATING
RETURNS
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55. The ‘Da Vinci’ Code
CALCULATING
RETURNS
Marked-to-market
portfolio value for day t
Vt = Bt - SSt deltat*Bt
Sunday, July 11, 2010
56. The ‘Da Vinci’ Code
CALCULATING
RETURNS
Marked-to-market
portfolio value for day t
Vt = Bt - SSt deltat*Bt
::Therefore::
((Vt - Vt - 1) + (SSt-1*OBRt – s – dyt)-(Bt-1-Capt-1)*Lt-1)
Rt =
Capt-1
Daily return on the
positive carry trade
Sunday, July 11, 2010
58. The ‘Da Vinci’ Code
OPTIMIZING
(deltat*Bt*OBRt – s – dyt)
CFDs as proxies
for shorting
((0.9*deltat*Bt*OBRt)-dyt)
Sunday, July 11, 2010
59. The ‘Da Vinci’ Code
OPTIMIZING
(Capt*OBRt + (Bt – Capt)*Lt)
Minimizing Lt
Bt*OBRt
Sunday, July 11, 2010
60. The ‘Da Vinci’ Code
OPTIMIZING
((0.9*deltat*Bt*OBRt)-dyt)
Maximizing OBRt
(20(0.9*deltat*Bt*OBRt) – dyt)
Sunday, July 11, 2010
61. The ‘Da Vinci’ Code
REAL LIFE
APPLICATION
Sunday, July 11, 2010
62. The ‘Da Vinci’ Code
REAL LIFE
APPLICATION
Olam 6% CB 15102016
Issue Date 16 October 2009
Conversion Price $3.0853/share
Min. Denomination US$100,000
Issue Price 1.0 Par
Board Lot Size US$200,000
Fixed Exchange Rate S$1.440=US$1.00
Conversion Ratio 93,345.8659
Overnight Bank Rate 0.2796%
Singapore Prime rate 5%
Delta 0.6
Capital Base 15% of long position
Sunday, July 11, 2010
63. The ‘Da Vinci’ Code
REAL LIFE
APPLICATION
(RESULTS)
Carryt -$23,241.8
OCt $87,400
Return 58.26%
Fund Management
Fees (20/2) $148,172
Sunday, July 11, 2010
64. The ‘Da Vinci’ Code
REAL LIFE
APPLICATION
(RESULTS)
Carryt -$23,241.8
OCt $87,400 BOOMZ!
Return 58.26%
Fund Management
Fees (20/2) $148,172
Sunday, July 11, 2010
