Tuesday, May 18, 2010

Reverse Convertibles tied to TiVo Stock

J. P. Morgan's 64% Note Tied to TiVo Stock Shows Risks of Reverse Convertibles

Bloomberg issued a news release reporting on the reverse convertible, a structured product, on TiVo.

A reverse convertible note is a type of structured product that is linked to an equity security or an index. It is a short-term note that pays a relatively high coupon rate compared to traditional notes. The returns of the note at maturity depends on whether the equity, called ‘reference asset’, falls below a pre-specified trigger price during the term of the note. If it does, then the note returns the market value of the number of shares of the reference asset which could have been purchased on the note’s pricing date with the note’s face value. If it does not, then the note returns its face value.

SLCG has written a paper ‘What TiVo and JP Morgan teach us about Reverse Convertibles’ that values and analyzes a large sample of reverse convertible notes. We find that these notes are largely and consistently overpriced, yet reverse convertibles continues to be sold which, combined with the complexity of and the lack of a secondary market for these notes, implies that investors do not fully understand the returns and risks of these notes.

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