The Barrier Reverse Convertible

Feb 13, 2022 | Products

The Barrier Reverse convertible is one of the simplest and oldest form of a yield enhancement structured product.

Example of Barrier Reverse Convertible

An example of such a product is defined by the following elements:

  • Issuer : Bank ABC
  • Maturity : 18 months
  • Underlying : Microsoft Corp (MSFT)
  • Currency : USD
  • Denomination : 100,000
  • Coupon rate : 4% per annum
  • Coupon Frequency : quarterly
  • Barrier Type : Continuous
  • Barrier Level : 65%

To make the description of the payoff easier, let’s note S(t) the price of the underlying S at time t.
S(0) will then ben the price the underlying at time 0.
S(T) will be the price of the underlying at maturity.

The payout of such a product will be (and subject to the issuing bank ABC not defaulting) :

  • During the life of the product
    The coupon of 4% per annum will be paid on a quarterly basis (1.00% per quarter). That coupon is guaranteed in the sense that it is paid irrespective of the performance of the underlying security (here Microsoft)
  • At maturity,
    • If the underlying has never traded below the barrier during the the life of the product, the redemption of the note will be 100%
    • If the underlying has traded below the barrier at some time during the the life of the product, the redemption of the note will be
      • 100% if S(T) is greater or equal to S(0)
      • S(T)/S(0) if S(T) is strictly less than S(0)

For the investor, buying a reverse convertible is equivalent to

  • Being long a zero-coupon bond issued by the issuing bank
  • Receiving regular guaranteed coupons from that issuing bank
  • Being short an at-the-money put option , with continuous Knock-In on the underlying security

The barrier can have different types, depending on how it is observed :

  • Continuous or American: The barrier is observed continuously and any intraday tick is observed
  • Final or European: the barrier is only observed once at the maturity of the product
  • Daily on close: This variation is very similar to the continuous observation but only the closing prices of the security are considered
Eric Barthe

Eric Barthe

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