Convertible bonds were first issued in the United States in the nineteenth century. A simple convertible bond is a relatively straightforward security. It is simply a regular corporate bond, paying a fixed coupon, with security, maturing at a certain date with an additional feature allowing it to be converted into a fixed number of the issuer’s common stock. According to Calamos (2003) this convertible clause was first added to fixed income investments to increase the attractiveness of investing in rail roads of what was then the emerging economy of the United States.
Convertible bonds have grown in complexity and are now issued with features such as put options, call protection, ratchet clauses, step up coupons and floating coupons. Perhaps due to this complexity relatively few individual or institutional investors incorporate convertible into their portfolios. It has been estimated that hedge funds account for seventy percent of the demand for new convertible issues and eighty percent of convertible transactions (see Barkley (2001) and McGee (2003)).
Risk management today is in the spotlight, being tested by unprecedented turbulence in the financial markets, including depressed asset prices, reduced liquidity in many markets, and a contraction in the credit markets. The changed marketplace has affected every segment of the financial services industry including banks, insurance companies, and asset management firms. While the confluence of these events has challenged risk management within financial firms, these events have also demonstrated the need for enhanced risk management capabilities and reiterated a basic principle – risk and return are generally correlated and should be evaluated together.
Boards of directors at many institutions may need to continue their efforts to become more actively involved in understanding the risks within the business, approving organizational risk appetite and tolerance, and providing increased oversight over business decision-making and the consideration of relevant risk management issues. Management may require more comprehensive metrics and tools to adequately assess all the risks inherent in the range of complex products. And institutions may need to more fully recognize and effectively manage liquidity risk, which has afflicted the markets for securitized products as well as the broader financial markets.
In 2003, EBay, the global leader in online auctions, was selected to become part of the FIN 284 portfolio based on the company’s tremendous growth prospects and strong industry position. In the two and a half years since the purchase the stock price has increased significantly and our group has begun to reexamine the security to determine if it is in the class’s best interest to continue to hold the shares.
The majority of our research focuses on areas such as the future of the online auction industry, the potential growth prospects for EBay, and the risks of holding the security versus the benefits of taking profits. To assist in the evaluation of the security our group research includes a valuation model and technical analysis.
