Every convertible arbitrage P&L attribution starts from the term sheet: how many shares you get on conversion, when the issuer can call, and whether conversion is optional or forced. Misread the conversion ratio or soft-call trigger and the "cheap" bond you bought is a different instrument from the one your model priced. This note fixes the slang — payoff, conversion mechanics, call and put, issuer and investor motives — so later notes can talk about floors, trees, and delta hedges without redefining the contract.
Learning objectives. By the end of this note you should be able to:
- write the maturity payoff and the bond-plus-embedded-call rewrite;
- compute conversion ratio and conversion price from each other given par;
- distinguish optional conversion, forced conversion after a call, and American-style conversion windows;
- state why issuers accept a lower coupon and why investors accept equity dilution risk.
In this lesson
- The maturity payoff
- Conversion ratio and conversion price
- Call, put, and forced conversion
- Why the instrument exists
Before you start
The full lesson, with worked examples and exercise solutions, is for members.
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