A financial structure that combines both an option and an asset swap. In other words, it is an option on a convertible bond which allows the holder to split up the underlying bond into its components: 1) a straight bond and 2) an option to buy stock (i.e., a stock call option). By this American option, the buyer can exercise on the underlying bond in exchange for paying a floating strike. In essence, it helps acquire exposure to the convertible bond and its equity performance, and at the same time eliminate the default risk on the issuer (the name).
The straight bond component is a source of relatively stable returns over its life, whilst the option component enables the holder to take advantage of any anticipated share price appreciation. For example, hedge funds might resort to the sale or purchase of asset swapped convertible option transaction (ASCOTs) (short or long positions) in order to enhance the leverage capability of their portfolios. To that end, the straight bond component is typically separated into smaller chunks (baby bonds) that can be sold to small investors, while the call option is retained by the holder so that he can avail himself of any anticipated upside movement in the underlying equity price.
ASCOTs were first introduced in the late 1990s by Morgan Stanley based on the concept of asset stripping.
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