Asset Swapped Convertibles

Asset Swapped Convertibles involve decomposing convertible bonds into separate bond and equity option components, with the credit portion retained and conversion option sold to different investors. Investment banks facilitate these transactions, buying convertibles and selling credit-linked notes to fixed income investors while selling equity options to equity derivatives desks or hedge funds. For example, a 2% convertible might be asset swapped into LIBOR+150bp notes for credit investors and call options for equity investors. This market exceeds $50 billion annually, enabling convertible arbitrage strategies and allowing pure credit exposure without equity risk. Benefits include enabling credit-only investors to access convertible issuers, providing cheap equity volatility for option buyers, and improving convertible bond liquidity. Pricing requires modeling credit spreads, equity volatility, and correlation between credit and equity. Risks include basis risk between components, counterparty exposure, and documentation complexity. Asset swapped convertibles demonstrate financial engineering’s role in decomposing hybrid securities to match specific investor preferences, though added complexity requires sophisticated risk management.