Reverse Convertible Coupons Reflect the Packaged Product Price

Summary

The document addresses whether a reverse convertible coupon should exceed the sum of a risk-free rate and the premium from a short put because the put premium could earn interest after inception. The answer emphasizes that a buyer purchases a packaged product: the issuer or structurer sets its price and cash flows, and the buyer generally does not receive or separately invest the put premium.

The quoted coupon therefore cannot be inferred simply by compounding a displayed put premium. The product’s price depends on its expected cash flows and structuring terms. In the example, a lower coupon could be paired with a lower upfront purchase price. The discussion is conceptual and offers no full valuation model; actual terms depend on how a particular product is structured.

Key ideas

• A reverse convertible is a packaged product whose coupon and price are set by its structurer.
• The buyer generally cannot separately invest the short put premium received within the structure.
• Coupon levels should be considered alongside the product’s upfront price and expected cash flows.
• Adding interest to a put premium does not by itself determine the coupon a buyer should receive.

Tags

# Reverse convertible coupon determination


# Reverse convertible coupon determination












I had a question about the coupon level determination for a simple reverse convertible product. Assuming risk free rates are 4% while premium on short put is 5%, typical text-books would then quote the coupon at 9%.

Can't I expect a slightly higher coupon, by reinvesting the put premium received at inception at the risk free rate ? 4 + 5*1.04 = 9.2 % ?

Thanks

## Answer by AKdemy (score 1)

https://quant.stackexchange.com/a/78213

You personally cannot invest the coupon. In fact, you typically don't even see what the value of the short put is on the first place.

If you buy a RC, someone else packages that product for you. Ultimately it's how the structurer defines what you get as the buyer (see here for an autocallable; a RC is practically the same without interim payments).

The price of the structure will depend on the cashflows to be expected. If they would quote a lower coupon than 9% in your example, you would just pay less up front for the product.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.