I'll bite when he guarantees me an 11% return like he did for Prince Alwaleed - sorry meant Abu Dhabi. What? My money isn't as green as his so I have to accept 7%? Pleeeeeezzzzzz...

Vik, you can go beg for money somewhere else...

At around $27, Citigroup stock has now fallen more than 50% from the all-time peak reached barely 12 months ago. The shares literally cannot fall as far as they have already, even if they were to go to zero.

So in a technical sense, the worst is already past.Isnt the opposite true, in that now an additional $7/share decline is a 26% loss in value, whereas a year ago a $7/share decline was only 13%?

Abu Dhabi deal guaranteeing 11% for years. Citi is worse off now and they want to pay 7%. Vik - nfln - read between the lines

Is there any word or estimate on when this will happen?

ChiefRocka said:I'll bite when he guarantees me an 11% return like he did for Prince Alwaleed - sorry meant Abu Dhabi. What? My money isn't as green as his so I have to accept 7%? Pleeeeeezzzzzz...

Vik, you can go beg for money somewhere else...

I feel so cheap, I would bite at a 6% CD, maybe lower.

Note (before you read this any further): apparently, according to ChiefRocka - and I believe he is correct, what is being offered by Citi is a convertible stock and what I have described below is a convertible bond, two different animals.

The convertible is a bond with a built-in call option (it's not a stock).

The call strike price, per the WSJ article, is set at current price + 20%. When the convertible is issued, that strike price will be fixed. Assuming, say, today's closing price, that strike price is 1.2 * 26.24.

There was nothing mentioned about the maturity term of the bond part or the expiration term of the built-in option. See the following quote where I got the 20% figure from:

[Oh, and investors will have the ability to swap their preferreds into ordinary shares if the price of the latter recovers 20% from its current depressed situation.]

To properly value the convertible, you need the following:

- current C stock price,
- C volatility surface, obtained from the listed options,
- C credit spread, obtained from either from the CDS (credit default swaps) or the bonds (I don't know if there are enogh C bonds in circulation),
- the exact terms and conditions of the convertible, including interest rate, term of the convertible, term of the embedded call option and its strike (is this a "European" or "American" call), AND how this convertible issue places in the C debt hierarchy, i.e. in case shit happens, does your convertible rank more or less senior compared to Prince Alwaleed's 11% convertible.

Also, despite what people are saying here about "minimum" default risk, there are actually risks to owning this convertible:

- widening C credit spread. This will reduce the future value of your 7% fixed coupon,
- decreasing C stock price. This will reduce the value of the embedded option,
- decrease in C option volatility. This will reduce the value of the embedded option,
- up-ward shift in USD interest rate curve. This will reduce the value of your 7% fixed coupon,
- passage of time. This will decay the option value,

The reasons are that the above 5 parameters were used in computing the fair price of the convertible at the time of issue, and they should be used to compute the fair price of the convertible at any future date.

Of course, the fair price of the convertible might be different than the market price. But there are arbitrage groups out there, called convertible arbitrage, that would start trading the convertible, and the market price would tend to converge to the fair (model) price.

Why would you care about the price of the convertible (market or model)?

Well, if you bought that in your brokerage account, you would see its market value reflected in your portfolio. So if you bought at $100, and price drops to $90, you will be down 10%.

A simple scenario under which your convertible loses value.

1. On Feb 1st, the convertible is issued, you pay $100 per share, and get 100 shares,
2. Subsequently, C balance sheet situation gets worse, bad news come out, and C decides to issue another one, this time at 9%. At this time your 7% convertible, originally purchased at $100, now sells for, say $90.

Why would anyone hold the regular C shares when you can hold the preferred stock.

Remember that convertible HAS an option to buy a share but IS not a share yet. The strike price is set at current price + 20%, so the embedded option simply has some time value. There is no guarantee that during the life-span of the embedded option it will be in the money.

P.S. Reading the link provided by ChiefRocka a few posts above, it appears that the 11% convertible sold to Abu Dhabi pays 11% until March 2010. From then on, that stake ($7.5B) MUST be converted to Citi shares. So in that sense, it is not really an option. It has some elements of a forward contract (agreement to buy at a fix price in the future, where the price is fixed in the present). However, it has floors and ceilings, so definitely has optionality. Anyway, read that link - it is quite interesting.

That's a useful analysis, thanks. I'm no finance guru (in the sense of knowing anything about stocks), so I have a question to cut to the core.

Assume you think that Citibank isn't going to go bankrupt and that interest rates are not going to go up significantly in the near term. What's the downside to investing in these once they're issued? Can't you just sit back and rake in the 7% interest in dividends, apart from the market value of the security or whether the option is in the money? Or (probably) am I fundamentally misunderstanding how this works?

tolamapS said:The convertible is a bond with a built-in call option (it's not a stock).How is it a bond when it clearly says that it is a preferred stock in the OP's wsj link? With a preferred stock, the issuer can withold the 7% dividend, with a bond the issuer does not have the option of suspending the coupon.

ChiefRocka said:tolamapS said:The convertible is a bond with a built-in call option (it's not a stock).How is it a bond when it clearly says that it is a preferred stock in the OP's wsj link? With a preferred stock, the issuer can withold the 7% dividend, with a bond the issuer does not have the option of suspending the coupon.

Good questaion. I am not sure what the correct way is to name the "thing", but let's understand what the future cash flows are.

1. Quote from the WSJ:

"The stock will have a 7% yield. These are "preferred" stocks, which means they're a little like bonds. The dividends won't rise: But they are pretty secure, as they should get paid in full before common shareholders get a penny."

So the yield part works just like a bond. I am also going to venture and say that it is principal protected, i.e. you get $1000 worth of the "thing" today, earn your 7% coupon for the duration of the "thing", and if you are not interested in conversion into stock, you get your principal back at the end. In other words, it is a debt instrument.

If Citi tries to touch the yield of that "thing", it will trigger a default event. That is another feature that separates a debt instrument from an equity instrument. In case of an equity instrument, company can announce and cancel a divident - no bankruptcy triggered. Also the equity stock price moves at market's will - no principal protection there.

When a company is unable to pay the coupon of a debt instrument - boom, bankruptcy is triggered.

2. It is definitely not a stock. The buyer does not have equity rights. However, it has an embedded option on equity. Read this part:

"Oh, and investors will have the ability to swap their preferreds into ordinary shares if the price of the latter recovers 20% from its current depressed situation. In other words, you get a great yield, some pretty good security, and almost all the upside if things improve."

To me, that bolded part is just like a call option.

3. The only remaining thing is how senior is that "thing" in the event of bankruptcy. I am not a bankruptcy or enterprise structure expert, but typically the seniority of the various stakeholders get prioritized as follows:

(1) Senior debt holders,
(2) Junior debt holders,
(3) Prefered holders,
-----------------------
(4) Common stock holders.

So when company throws the white flag, the payout order is according to that list, i.e. the bankruptcy judge makes sure that group 1 gets paid, then group 2, then group 3, then group 4. Typically, bankruptcy means there is no penny left for group 4, and that groups 1-3 don't get all their money back.

Consequently, because of that assymetry, the voting order is usually reversed. Usually, only the group 4 stakeholders can vote on company matters. That's why I drew the line. Group 3, by the virtue of the conversion option, can become common stock holders, so they are the closest to getting voting rights.

Basically, to understand what you are buying, you need to understand the future cash-flows associated with it, and the risks to owning it. All I said was that the convertible sounds like a bond with a built-in call option - just like many convertibles are.