JUAN RAMIREZ currently works in an international bank and is responsible for the marketing of strategic derivatives to Iberian corporate and institutional clients. After earning a bachelor degree in electrical engineering at the ICAI University in Madrid, he joined the consumer products group at Arthur Andersen where he spent five years gaining a substantial exposure to the accounting world. After earning an MBA degree from University of Chicago, Mr. Ramirez moved to London to work at Chase Manhatten(currently JP Morgan). He has also working at Lehman Brothers, Barclays Capital and Banco Santander. Mr. Ramirez has devoted more than 15 years marketing structured derivatives solutions. During the last seven years he has been working in strategic equity transactions with a strong accounting, capital markets, tax and regulatory angle. Mr. Ramirez is married and has three childen.

Preface xvii

About the Author xix

1 Main Strategic Equity Derivative Instruments 1

1.1 Equity Forwards 1

1.1.1 Equity Forwards 1

1.1.2 Example of a Cash-settled Equity Forward on a Stock 2

1.1.3 Example of a Physically Settled Equity Forward on a Stock 3

1.1.4 Calculating the Forward Price of a Stock 4

1.2 Equity Swaps 6

1.2.1 Total Return Equity Swaps 6

1.2.2 Price Return Equity Swaps 7

1.2.3 Case Study: Physically Settled Total Return Equity Swap on Deutsche Telekom 7

1.2.4 Case Study: Cash-settled Total Return Equity Swap on Deutsche Telekom 12

1.2.5 Determination of the Initial Price 15

1.2.6 Determination of the Settlement Price 16

1.2.7 Equity Notional Resets 17

1.2.8 Case Study: Total Return Equity Swap on EuroStoxx 50 17

1.2.9 Compo Equity Swaps 21

1.2.10 Quanto Equity Swaps 23

1.2.11 Uses of Equity Swaps 25

1.3 Stock Lending and Borrowing 26

1.3.1 Stock Lending and Borrowing 26

1.3.2 Stock Lending/Borrowing Transaction Flows 27

1.3.3 Counterparty Credit Risk 28

1.3.4 Advantages of Stock Lending and Borrowing 29

1.3.5 Drawbacks of Stock Lending and Borrowing 29

1.4 Call and Put Options 30

1.4.1 Call Options 30

1.4.2 Put Options 33

[...]opean vs. American Style 36

1.4.4 Time Value vs. Intrinsic Value 36

1.4.5 In, At or Out-of-the-money 37

1.4.6 Variables that Influence an Option Price 38

1.4.7 Historical Volatility vs. Implied Volatility 40

1.4.8 Put-Call Parity 41

1.4.9 Options' Sensitivities, the "Greeks" 42

1.4.10 Delta Hedging 44

1.4.11 Offsetting Dividend Risk 45

1.4.12 Adjustments to Option Terms Due to Other Corporate Actions 46

1.4.13 Volatility Smile 47

1.4.14 Implied Volatility Term Structure 48

1.4.15 Composite and Quanto Options 49

1.5 Dividend Swaps 50

1.5.1 Dividend Swaps 50

1.5.2 Applications of Dividend Swaps 50

1.5.3 Risks 52

1.5.4 Main Dates in a Dividend Distribution 52

1.5.5 Case Study: Single-stock Dividend Swap 52

1.5.6 Case Study: Index Dividend Swap 56

1.5.7 Pricing Implied Dividends 58

1.6 Variance Swaps and Volatility Swaps 58

1.6.1 Variance Swaps Product Description 59

1.6.2 Calculation of the Realized Volatility and the Realized Variance 61

1.6.3 Volatility Swaps Product Description 62

1.6.4 Volatility Swaps vs. Variance Swaps 63

1.6.5 Applications of Variance and Volatility Swaps 63

2 Equity Capital Markets Products 65

2.1 Main Equity Capital Markets Products 65

2.1.1 Capital Increase Products 65

2.1.2 Secondary Placement Products 66

2.1.3 Equity-linked Products 66

2.2 Initial Public Offerings 66

2.2.1 Product Description 66

2.2.2 Benefits of Going Public 67

2.2.3 Drawbacks of Going Public 67

2.2.4 The IPO Process 68

2.2.5 Phase 1: Preparation of the Company 68

2.2.6 Phase 2: Preparation of the Offering 69

2.2.7 Phase 3: Marketing of the Offering 75

2.2.8 Phase 4: Placement of the Offering 77

2.2.9 Key Success Factors Affecting an IPO 80

2.2.10 Key Risk Factors Affecting an IPO 81

2.2.11 Case Study: Visa's IPO 82

2.3 Case Study: Google's Dutch Auction IPO 85

2.4 Rights Issues (or Rights Offerings) 87

2.4.1 Product Description 87

2.4.2 Main Definitions of a Rights Issue 88

2.4.3 Advantages and Weaknesses of a Rights Issue 89

2.4.4 Rights Offerings Success Factors 90

2.4.5 Calculation of the TERP 90

2.4.6 Case Study: ING's [...] billion Rights Issue 91

2.5 Rights Issues of Convertible Bonds 95

2.5.1 Case Study: Banco Popolare Rights Issue of a Convertible Bond 95

2.6 Accelerated Book-Buildings 98

2.6.1 Product Description 98

2.6.2 Advantages and Weaknesses of an ABB 99

2.6.3 Estimating the Discount 99

2.6.4 Case Study: IPIC's Disposal of 11.8% of Barclays 100

2.7 At the Market Offerings 100

2.7.1 Product Description 100

2.7.2 Case Study: US Treasury Placement of Citigroup Shares 101

3 Convertible Bonds and Mandatory Convertible Bonds 103

3.1 Introduction to Convertible Bonds 103

3.1.1 What are Convertible Bonds? 103

3.1.2 Convertible vs. Exchangeable Bonds - Exchange Property 104

3.2 Who Buys Convertible Bonds? 105

3.3 Convertible Bonds: The Issuer Perspective 106

3.4 Case Study: Infineon's Convertible Bond 107

3.4.1 Main Terms of Infineon's Convertible Bond 107

3.4.2 Conversion Price, Ratio, Premium and Lockout Period 108

3.4.3 Hard No Call Period, Hard Call and Soft Call Options 109

3.4.4 Put Rights 110

3.4.5 Additional Clauses: Cash Option, Cash Top-up, Lock-up Period, Tax Call 111

3.4.6 Value of a Convertible Bond at Maturity 112

3.4.7 Value of a Convertible Bond during its Life 112

3.5 Delta Share Repurchase Strategy 114

3.6 Mandatory Convertible Bonds 115

3.7 Rationale for Issuing Mandatory Convertibles 115

3.8 Rationale for Investing in Mandatory Convertibles 116

3.9 Fixed Parity Mandatory Convertibles 116

3.9.1 Case Study: Banco Santander's Fixed Parity Mandatory Convertible 116

3.10 Variable Parity Mandatory Convertibles 118

3.11 Dividend Enhanced Convertible Securities 118

3.11.1 Conversion Mechanics of a DECS 118

3.11.2 Anatomy of a DECS 120

3.11.3 Embedded Derivatives in a DECS 121

3.11.4 Pricing a DECS 122

3.12 Case Study: UBS's DECS 122

3.13 Special Clauses in Convertibles 124

3.13.1 Dividend Protection Clauses 124

3.13.2 Coupon Deferral Clauses 125

3.13.3 Call Option Make-whole Clauses 126

3.13.4 Change-of-control Make-whole Clauses 126

3.13.5 Clean-up Call Clauses 127

3.13.6 Net Share Settlement Clauses 127

3.14 Contingent Convertibles: FRESHES, CASHES and ECNS 127

3.14.1 Case Study: Fortis's FRESH Instrument 128

3.14.2 Case Study: Unicredit's CASHES Instrument 131

3.14.3 Case Study: Lloyds ECN 136

3.14.4 Case Study: Rabobank's SCN 139

4 Strategic Equity Transactions around Convertible/Exchangeable Bonds 141

4.1 Issuing an Exchangeable with a Third-party Guarantee 141

4.1.1 Case Study: Controlinveste's Exchangeable Bonds on Portugal Telecom 141

4.1.2 Transaction Overview 142

4.1.3 Dividend Swap and Transaction Flows during the First Four Years 143

4.1.4 Transaction Flows in Case of Exchanges or at Maturity 145

4.1.5 Exchange Property Pledge and other Security Mechanisms 146

4.1.6 Attractiveness of the Transaction to the Issuer and to BCP 147

4.2 Issuing a Convertible Through a Third Party 147

4.2.1 Case Study: Novartis LEPOs and Put Options with Deutsche Bank 147

4.2.2 Transaction Overview 147

4.2.3 Deutsche Bank's Exposure to Novartis's Stock Price 149

4.2.4 Effect of Deutsche Bank's Zero-coupon Convertibles on the Exchange Price 151

4.2.5 Attractiveness of Deutsche Bank's Zero-coupon Exchangeables to Investors 152

4.2.6 Advantages to Novartis and Relevance of a Call Right 152

4.3 Crystallizing a Gain in a Convertible Investment Through Warrants 153

4.3.1 Case Study: Richemont Warrants Issue on Back of Convertible Preference Shares 153

4.3.2 Warrants' Terms 154

4.3.3 Analysis of R&R