Praise for Global Convertible Investing: The Gabelli Way "Hart has just written the best book on our product. Everyone will learn something from this Graham & Dodd for convertibles ...a must-read for investors." Lorraine Lodge Director, Convertible Research, ING Barings "With the global convertible markets going from strength to strength, Global Convertible Investing is an excellent guide to this exciting asset class." Grant Mackie Head of International Convertible Bond Research, Lehman Brothers "Hart Woodson has written the most definitive work on convertibles to date. Not only does he provide a fully comprehensive study of the technical dynamics that are the essential ingredients of the convertible instrument, he discusses at length the myriad of other considerations that go into making an intelligent investment decision." Richard C. Nelson Director, Convertible Research, ABN AMRO "A pragmatic, plain-English and incredibly comprehensive tutorial of the convertible securities marketplace. A must-read for anyone considering issuing or investing in convertibles." Kendrick Wakeman Director, Convertible Research, Wachovia Securities, Inc. "Easily the most carefully constructed work on the world of convertible bonds. Hart combines the insights of a practitioner with the precision of an academic." John Wagner Managing Partner, Camden Asset Management, LP "This book is an essential guide to convertibles for new as well as existing convertible investors. It is comprehensive, and it reflects Hart's extensive experience as a Global Convertible Portfolio Manager." Anand Iyer Group Head, Convertible Research, Morgan Stanley "All groups of investors will gain from this comprehensive and insightful book." James Peattie Head of Equity Derivative Research, Dresdner Klienwort Wasserstein "The book admirably combines a simple down-to-earth view of convertibles with technical and analytical rigor. Hart Woodson manages to discuss topics interesting to some but intimidating to many, such as convertible pricing models or convertible arbitrage strategies, in a way that makes it easily digestible and fun." Katalin Tischhauser Head of International Convertible Research, Goldman Sachs
'Hart has just written the best book on our product. Everyone will learn something from this Graham & Dodd for convertibles . . . a must-read for investors.' -Lorraine Lodge Director, Convertible Research, ING Barings 'With the global convertible markets going from strength to strength, Global Convertible Investing is an excellent guide to this exciting asset class.' -Grant Mackie Head of International Convertible Bond Research, Lehman Brothers 'Hart Woodson has written the most definitive work on convertibles to date. Not only does he provide a fully comprehensive study of the technical dynamics that are the essential ingredients of the convertible instrument, he discusses at length the myriad of other considerations that go into making an intelligent investment decision.' -Richard C. Nelson Director, Convertible Research, ABN AMRO 'A pragmatic, plain-English and incredibly comprehensive tutorial of the convertible securities marketplace. A must-read for anyone considering issuing or investing in convertibles.' -Kendrick Wakeman Director, Convertible Research, Wachovia Securities, Inc. 'Easily the most carefully constructed work on the world of convertible bonds. Hart combines the insights of a practitioner with the precision of an academic.' -John Wagner Managing Partner, Camden Asset Management, LP 'This book is an essential guide to convertibles for new as well as existing convertible investors. It is comprehensive, and it reflects Hart's extensive experience as a Global Convertible Portfolio Manager.' -Anand Iyer Group Head, Convertible Research, Morgan Stanley 'All groups of investors will gain from this comprehensive and insightful book.' -James Peattie Head of Equity Derivative Research, Dresdner Klienwort Wasserstein 'The book admirably combines a simple down-to-earth view of convertibles with technical and analytical rigor. Hart Woodson manages to discuss topics interesting to some but intimidating to many, such as convertible pricing models or convertible arbitrage strategies, in a way that makes it easily digestible and fun.' -Katalin Tischhauser Head of International Convertible Research, Goldman Sachs
PART ONE: THE CONVERTIBLE BASICS 1. Anatomy of a Convertible What Is a Convertible? Why Should an Investor Consider Convertibles? Why Should a Company Issue a Convertible? Nomenclature Investment Value Convertible Performance. 2. Convertible Structures: Let Me Count the Ways Zero-Coupon Convertible Bonds (OID) Puttable Convertible Bonds Coupon Paying Convertible Bonds Convertible Preferred Stock Mandatory Convertible Securities (MCS) Other Features Other Convertible Structures 3. Understanding the Prospectus: Caveat Emptor Call Protection Dilution Protection (Extraordinary Dividends) Ranking Shares Sleeping Investor Clauses Convertibility Ranking: Senior or Subordinated Takeover Protection Redemption Terms (Cash or Stock) Conditional Income Conclusion 4. Global Convertible Markets Size Credit Quality Sector Allocation Characteristics Recent Trends 5. Benchmarks and Performance: Global and Domestic Indices Benchmarks Convertible Indices Domestic Convertible Indices Global Convertible Indices Convertibles as an Asset Class Additional Notes 6. Convertible Valuation: A Cultural Overview Japan: Convertibles as an Equity Alternative United Kingdom: The Dividend Cross-Over Method Netherlands: The Total Premium Method Option Pricing Models
PART TWO: CONVERTIBLE PRICING AND VALUATION 7. Option Pricing Theory Introduction Establishing the Boundary Conditions of a Call Option How to Price a Call Option: A Leveraged Position in the Stock No Arbitrage Opportunity How to Price a Call Option: Discounted Expected Return Deriving a General Formula to Price a Call Option The BlackScholes Option Pricing Formula Adjusting for Stocks Paying a Known Dividend Yield 8. Using the BlackScholes Model to Price a Convertible Bond Bond plus a Call Warrant Warrant versus Option: Dilution Cash Pay versus Exchange The Investment Value Adjustments to Investment Value: Maturity Date and Accrued Interest The Warrant Value 9. Sensitivity Analysis: The Greeks Changing Share Price: Delta Rate of Change of Delta: Gamma Where Is Gamma Maximized? Changes in Volatility: Vega What Is Volatility? Changes in Interest Rates: Rho and Duration The Bond Effect: Duration The Warrant Effect: Rho The Passage of Time: Theta How Much Time Do I Have Left?
10. Convertible Bond Pricing: Binomial Trees Introduction Building the Stock Tree Building the Bond Tree Combining the Trees to Price the Convertible Bond Which Discount Rate to Use? Modifications to the Binomial Tree Dividends Adjusting for Call Options Adjusting for Put Options Adjusting the Model for Credit Risk 11. Convertible Bond Pricing: Put plus Stock plus Yield Advantage The Equity Portion The Put Option The Yield Advantage
PART THREE: CONVERTIBLE HEDGING 12. Convertible Arbitrage Is a Pure Arbitrage Possible? Why Hedge? What to Hedge? Who Hedges? The Ideal Hedge Candidate Volatility Unmasked Calculating Historic Volatility Convertible Hedging Strategies Creating the Short Position The Individual Investor The Institutional Investor The Nonresident Investor Executing a Short Sale The Neutral Hedge: No Leverage How Much to Hedge? Leveraging the Position under Regulation T (50% Leverage) Maximizing Leverage The Cost of Carry The Cost of Margin Debt The Short Rebate Neutral Hedge with Maximum Leverage Bull Hedge with Maximum Leverage Bear Hedge with Maximum Leverage When to Adjust the Hedge? How to Adjust the Hedge? When to Close Out the Hedge? What Can Go Wrong with the Hedge? Additional Notes: Deep In-the-Money Hedging Strategy 13. Hedging with Options Introduction Hedging Convertibles with Put Options: Full Hedge Hedging Convertibles with Put Options: Partial Hedge Hedging Convertibles with Call Options: Full Hedge Hedging Convertibles with Call Options: Partial Hedge Hedging Convertibles with Puts and Calls: Neutral Hedge 14. Hedging Interest Rate and Default Risk Hedging Interest Rate Risk The Cash Hedge: Shorting Treasuries The Futures Hedge The U.S. Treasury Bond Futures Contract Calculating the U.S. Treasury Bond Cash Futures Price Quoted Futures Price Constructing the Futures Hedge The Option Hedge Hedging Default Risk The Asset Swap Market The Mechanics: Initiating the Asset Swap Callable Asset Swap: Cash Flows Calling the Swap Callable Asset Swaps: Benefits and Drawbacks Credit Default Swaps 15. Hedging Currency Risk The Foreign Exchange Market Quotation Conventions Cross Currency Rates Spot and Forward Markets Forward Exchange Rates Money Machine? Fishers Theorem Forward Points: Discount or Premium? Hedging Currency Risk Case I: Foreign Currency Convertible with Foreign Currency Stock Case II: Local Currency Convertible with Foreign Currency Stock Case III: Foreign Currency Convertible with Local Currency Stock Case IV: Foreign Currency Convertible with a Different Foreign Currency Stock
PART FOUR: SPECIAL TOPICS 16. Mandatory Convertible Securities Introduction Valuing the MCS: Giving Up Downside Protection for Yield Valuing the MCS: From Buy Write to Call Spread The Mysterious Changing Conversion Ratio Performance Based Conversion Premium An MCS Example Definitions of Terms Sensitivity Analysis Price Effects of Hedging the MCS False Illusions in Valuing the MCS MCS Product Evolution Primary Distribution Swapping the Fixed-Income Component: Corporate versus Treasury MCS Other Mechanics of the Swap Secondary Distribution Accounting Treatment Sealed Air Corporation EPS Dilution: Tax-Deductible MCS (Treasury Stock Method) Treasury Stock Method: Income Statement and Balance Sheet Implications MCS: U.S. Tax Treatment Conclusion 17. Busted Convertibles: Market Overview What Is a Busted Convertible? When Is a Convertible Busted? Market Overview Busted Convertibles by Sector Busted Convertibles by Product Type Busted Convertibles by Credit Quality Rating Default Rates: Convertibles versus Junk Bonds 18. Investing in Busted Convertibles Advantages of Busted Convertibles Disadvantages of Busted Convertibles Old Economy Case Study: Mark IV Industries The Investment Opportunity Credit Analysis 101 Leverage Ratios Liquidity Ratios Coverage Ratios Efficiency Ratios Working Capital Management Profitability Ratios The Altman Z-Score Model: Predicting Bankruptcy Interpretation of the Altman Z-Score Conclusion (Mark IV) New Economy Credit Analysis: Global TeleSystems Investment Opportunity Credit Analysis Conclusion (Global TeleSystems) 19. The Investment Decision Why Convertibles? Convertibles: Better than a Balanced Portfolio? The Convexity Ratio Convertibles: The Investment Decision Equity Analysis 101: Growth Stocks The Equity Risk Premium The Terminal Multiple Equities 101: Value Stocks Intrinsic Value Private Market Value (PMV) Equity Analysis 101: Discounted Cash Flow Analysis (DCF) Convertibles: The Technical Investment Decision Building a Diversified Convertible Portfolio Sell Discipline
EPILOGUE APPENDIX 1: MCS NAME VARIATIONS APPENDIX 2: USEFUL INTERNET SITES GLOSSARY OF NOTATION GLOSSARY OF TERMS BIBLIOGRAPHY INDEX
About Hart Woodson
HART WOODSON is the Managing Director of Gabelli Asset Management (UK) Ltd. He joined Gabelli (New York) in 1993 as a Senior Vice President and Portfolio Manager. Before joining Gabelli, he worked in Amsterdam, the Netherlands, for ABN AMRO Bank where he was responsible for new issue activities concerning convertible bonds, preferred shares, and warrants in all currencies. Prior to that he worked in New York for AMRO Bank in the Capital Markets Group and as a Credit Analyst for Meridien International Bank. Mr. Woodson graduated from Trinity College, Hartford, with honors in history and international relations. He received his master's degree in international affairs from Columbia University, New York, where he was elected an International Fellow.
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