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Tutorial: Reverse convertibles

What are Reverse Convertibles?

A Reverse Convertible is a bond with a very attractive interest rate. Given that this product is linked to a share (underlying share), coupons substantially exceed the market interest rate. In return for the high coupon, the investor also bears the risk from the share: at the end of maturity, the redemption of the Reverse Convertible is based on the price of the underlying instrument. If at the end of maturity the share price is above the initial value, the coupon and the nominal value are redeemed. If the share price at the end of maturity is below the initial value, the coupon is also redeemed, but the nominal value is redeemed in shares (physical delivery). The number of shares is based on their determined initial price. The remaining nominal value, which is below the value of one share, is redeemed in cash.

In addition to Reverse Convertibles with one underlying instrument, there are also Reverse Convertibles with more shares as underlying instruments. These multi-cash or multi-share bonds tend to pay higher coupons. The redemption of their initial value is based here on the share with the worst performance during the observation period. The coupon is redeemed as well, regardless of the trend of the underlying assets.

How do Reverse Convertibles work?

Reverse Convertibles are issued with an initially set fixed coupon which at the end of maturity pays substantially higher interest rates than the market. If in the observation period before the end of maturity the closing price of the underlying asset is above its set initial (Strike) price set at the beginning of the observation period, the Reverse Convertible is redeemed at its nominal value plus the coupon. If the closing share price is below its initial price, the investor is paid the nominal value in shares. The coupon is paid in cash. The number of shares to be delivered per nominal value is set according to the initial price. The remaining nominal value, which is below the value of 1 share, is paid in cash.

In case of Reverse Convertible with more than one underlying share, redemption is based on the share with the worst performance. If at the end of the observation period before maturity the price of this share is above its initial value, the bond is redeemed at its nominal value plus its coupon.

If at the end of maturity the price of the share with the worst performance is below its initial value, the investor again receives the nominal value redeemed in shares. The coupon is paid in cash. The number of shares to be delivered instead of the nominal value is set at the beginning of the period based on the initial price of the worst-performing share. The remaining nominal value, which is below the value of 1 share, is paid in cash.

Your benefits

Investors who do not expect any strong movements in shares can receive a high, fixed coupon when investing in Reverse Convertibles. The maximum return of the Reverse Convertible is limited to the value of the coupon. This form of investment is highly interesting in the environment of equity markets in which further strong growth is not expected.

Sale and holding of foreign securities

Income from holding or the sale of foreign securities (ISIN does not begin with CZ....) is not taxed by the final withholding tax, but is subject to an individual tax, and if not exempt from tax (exemption is only possible for income from the sale of a security), the taxpayer is obliged to declare this income in the relevant section of a tax return.

Terms and conditions of purchase

  • Reverse Convertibles can be purchased for the price based on the current exchange rate list for bonds.
  • You must have an asset account of investment instruments at Česká spořitelna to purchase a Reverse Convertible. There is no charge to set up an asset account which can be done at any branch of Česká spořitelna. The investor just needs to present a valid ID card while a legal entity needs to produce legal person documents.
  • You do not need a cash account at Česká spořitelna to purchase a bond. Funds for covering the purchase can be sent to the appropriate nominee account from any Czech currency account.
  • When selling in the form of subscription you need an investment account in the currency of the product, you cannot pay a subscription from a different type of cash account. There is no charge to set up an investment account which can be done at any branch of Česká spořitelna. The investor just needs to present a valid ID card while a legal entity needs to produce legal person documents.
  • The charge for one order to buy or sell bonds is CZK 100, regardless of the number of purchased or sold bonds. Subscription is free of charge.
  • The minimum investment is normally CZK 10,000.

Who can purchase?

  • A Czech or foreign national over the age of 18 (for a person underage his/her legal representative).
  • Legal entity, natural person-entrepreneur.
  • Other entities established under the laws of the Czech Republic, (foundations, movements, political parties).

Your advantages

  • You get a high, fixed coupon that is above the market interest rate
  • Reverse Convertibles tend to have short maturities.
  • The fixed coupon offers you a risk buffer.

Details you should be aware of

  • If you redeem shares at maturity, you may incur losses.
  • Between the share issue date and maturity, price fluctuations are possible, which means that you may incur loss by selling the Reverse Convertible.
  • Exit fee for early redemption in case of debt securities, premium bonds, subordinated and other bonds is 2% of the trade volume.
  • The potential return is limited to the coupon.
  • Reverse Convertibles are not covered by any deposit guarantee scheme. The investor is exposed to the risk that Erste Group Bank AG may not be able to meet its obligations arising from the Reverse Convertibles in the event of insolvency, over-indebtedness or from an official order (ball-in regime). A total loss of invested capital is possible.

How do Reverse Convertible react to…

… rising imarkets?
If the price of the underlying share rises, the price of the bond rises as well because the redemption of the nominal value is becoming more likely.

… stable markets?
In stable markets, the investor benefits from the fixed coupon and the redemption at nominal value at the maturity. The stable price has very little impact on the value of the Reverse Convertible, but this value rises as the remaining period to maturity shortens.

… falling markets?
If the price of the underlying share falls against its initial (Strike) value, the price of the Reverse Convertible falls as well because the redemption of the nominal value in shares becomes more likely. The fixed coupon shall be paid out in any case.


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