A barrier reverse convertible is a combination of a bearer bond – a security with which the issuer undertakes to provide a benefit – and a special put option on a classic financial asset, such as shares or raw materials. The financial asset is designated as the base value. During the term, a barrier reverse convertible grants a predefined coupon, regardless of how the base value develops. The maximum return from this type of product is therefore limited to the coupon.
The repayment on expiry, however, depends on the base value development (e.g. shares). What matters is whether the price of a base value has traded at or under the specified barrier during the term or at the agreed observation point. If the barrier reverse convertible includes several base values, the “worst of” principle typically applies. In other words, the relevant base value with the worst development is used to determine the repayment amount – regardless of whether this has fallen below the barrier. Because of the higher risk involved with several base values, these products generally offer a more attractive coupon than products with just one base value. This means that investors in barrier reserve convertibles primarily bear the market risk of the underlying base value. This makes barrier reverse convertibles most popular in stagnating markets.
However, barrier reverse convertibles can work in different ways. The rules that apply to reaching or falling below the barrier and the subsequent repayment depend on the type of barrier.