Asset Swapped Convertible Option Transaction (ASCOT) - Explained
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Table of ContentsWhat is an Asset Swapped Convertible Option Transaction?How does an Swapped Convertible Option Transaction Work?Asset Swapped Convertible Option Transaction - ASCOT and Hedge FundsAcademic Research on Asset Swapped Convertible Option Transaction
What is an Asset Swapped Convertible Option Transaction?
Asset Swapped Convertible Option Transaction - ASCOT is a structure in which convertible bonds are divided into two parts using convertible bond options. An isolated item is a bond with ordinary coupon payments and stock options as a call option. Through the ASCOT mechanism, investors can purchase options for convertible bonds without creating credit risk represented by corporate bonds.
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How does an Swapped Convertible Option Transaction Work?
Asset exchange options trading is done by writing US options to convertible bonds. Since the convertible bond itself is a share option of the transfer function, it already generates a compound option. The holder can use a US option at any time, but the strike price must include all the costs of liquidating the asset. ASCOT is a complex product that allows parties to play the role of shareholders and credit risk/bond buyers in original convertible bonds - convertible bonds themselves. Convertible bond traders face two risks. One of these is the inherent credit risk of the bond component. The other is the volatility of the stock market for the underlying asset since it affects whether the conversion option makes sense. For our purposes, suppose that the trader of convertible bonds wants to focus on the outlook for the equity of his convertible bond portfolio. To do this, he will sell convertible bonds to an investment bank, which acts as an intermediary in the transaction. The investment bank will create ASCOT by inscribing US options in the convertible portion of the bond and selling it to the trader in convertible bonds. The bond part of the convertible bond is then sold together with the payment to the other party who is willing to pay the credit risk at a fixed rate of return. Components of a bond are divided into smaller bonds and can be sold to several investors.
Asset Swapped Convertible Option Transaction - ASCOT and Hedge Funds
If a convertible bond is derived from credit risk by exchanging assets, the option holder has a violent, but the potentially valuable option. ASCOT, especially the stock component, is traded by hedge funds using convertible trading strategies. Due to the nature of complex options in ASCOT, hedge funds can easily increase the leverage of their portfolios and eliminate the credit risk of low-margin bonds and their equations.