Another Tom Wolfe special! (See: Asset-Backed Commercial Paper Money Market Fund Liquidity Facility)
Stocks and bonds offer different ways to invest in a company. They operate differently and have different pros and cons. Meanwhile, there are securities - called convertible bonds - that offer aspects of both types of investment. An asset swapped convertible option transaction re-separates these functions - splitting the bond and stock parts of a convertible bond.
A bond represents a loan. When you buy a bond, you are basically loaning money to a company, the grown-up version of spotting a buddy a few bucks for dinner. Eventually, hopefully, your buddy (or the company) will pay you back.
A stock, on the other hand, represents the purchase of ownership, or at least a part ownership. You aren't owed any money, as you would be with a bond, but you hope to make money as the company grows. As the company's value increases, the stock's value increases as well.
A convertible bond combines these investments. It is a bond, paying a yield and coming with a promise of repayment. However, the security also comes with an option to convert it into stock (hence the "convertible" part). So if you want, you can, under conditions laid out in the convertible bond, change the bond into a certain amount of stock at a certain price.
Here's the trade off, though: to convert into stock, you have to give up the bond. No more yield. No more guaranteed payments.
The ASCOT presents a "have your cake and eat it too" opportunity. The mechanics of the transaction are relatively complicated. But the result is splitting the bond part of the convertible bond from the stock part. You can hold the bond, with all the yield and guaranteed return, while still getting the upside available from owning stock.
Related or Semi-related Video
Finance: What are Convertible Bonds?9 Views
Finance a la shmoop what are convertible bonds? okay there's a joke about the
Inquisition in here somewhere or maybe something about Cossacks and 17th
century Russia what do you think animated musical or maybe a King Henry [King Henry VIII appears]
thing but yeah all that's different kind of conversion way more pedantically a
company might be having a hard time selling or issuing its bonds to Wall [Man with company briefcase for head meets man with Wall Street briefcase for a head]
Street in order for them to close the deal with their stock trading today at
25 bucks a share they might say well these bonds are convertible into 20 [Man with company for a head discussing bonds]
shares of our stock that is they would have a single thousand dollar unit of
that bond and it would convert into 20 shares which would then value the shares
at 50 bucks either thousand divided by 20 there's 50 it's an advanced calculus
sorry if you didn't have it which would sort of be you know the over/under price
at which bondholders would start to seriously look at converting their nice
safe bonds into those risky pesky equities well why would a company offer
convertible bonds instead of you know just vanilla bonds well if they were [Man discussing convertible bonds]
stuck paying 6% interest on just bonds but really could only afford to pay 4%
well they might get the interest rate discount by throwing in that equity
kicker in the bonds having that convertibility feature yes they would
suffer dilution at 50 bucks a share but that price is double and change where
the stocks out here so the company is probably thinking that it wouldn't mind
some dilution from these bonds being converted up there in stock price right [Arrow points to stock value mark on graph]
and remember the bonds pay the 4% interest along the way until they are
converted the moment those bonds are converted into equity well then the debt
on the balance sheet of the company and its obligation to pay that 4% yearly [Company balance sheet and interest highlighted]
interest goes mercifully away they print 20 more shares for each bond converted
and yes those shares may pay a dividend but as far as the convertible bonds go
they are thereafter converted and saved and remember Jesus Saves but Moses
invests
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