HKFRS 9 · Hong Kong
Convertible bond and preference share valuation
Fair value and split accounting for convertible notes, preference shares, FCNs, warrants and embedded derivatives — under HKFRS 9 and HKFRS 13.
The accounting problem these instruments create
A convertible instrument is rarely a single thing for accounting purposes. It typically bundles a debt host with one or more embedded features — a conversion option, a redemption or put option, a call option with a make-whole, sometimes a reset or ratchet on the conversion price. HKFRS 9 requires the issuer to determine whether those features are separated and measured at fair value through profit or loss, or whether the whole instrument is designated at fair value. Either way, someone has to produce a fair value that the auditor will accept.
For holders — funds, family offices and corporates carrying these instruments as investments — the same instrument has to be marked for reporting, often quarterly.
Instruments we value
- Convertible bonds and convertible notes, listed and unlisted
- Convertible preference shares with liquidation preferences, participation rights and anti-dilution terms
- Fixed coupon notes (FCNs) and equity-linked structured notes
- Warrants, share subscription rights and options over unlisted shares
- Embedded derivatives separated from a host contract
- Exchangeable bonds and instruments convertible into a different entity's shares
- Shareholder loans and related-party debt requiring a market interest rate assessment
Method
A convertible instrument's value depends on both credit risk and equity upside, which is why a simple discounted cash flow understates it. The usual route is a binomial tree that models the issuer's share price forward, applies the conversion decision at each node alongside any issuer call or holder put, and discounts the debt and equity components at appropriate rates — credit-adjusted for cash flows that would be settled in cash, risk-free for those settled in shares.
Where terms are path-dependent — a conversion price reset tied to an averaging period, a knock-in barrier, a coupon that steps according to a condition — Monte Carlo simulation replaces the tree because a lattice cannot represent the path.
Key inputs
- Underlying share price — market price for listed issuers, or a full equity valuation and waterfall allocation for unlisted ones
- Volatility — implied where a liquid option market exists, otherwise historical volatility from a justified peer set
- Credit spread — derived from the issuer's own traded debt if available, or from comparable-rated issuances in the relevant market, and reassessed at each measurement date
- Risk-free curve — matched to the instrument's currency and tenor
- Dividend assumptions and any contractual adjustment to the conversion terms
Preference shares are frequently misclassified. Whether a preference share is equity, a liability, or a compound instrument depends on its contractual terms — mandatory redemption, cumulative dividends, holder put rights and conversion mechanics all matter. The classification analysis has to precede the valuation, because it determines what is being measured. We flag it during scoping rather than discovering it mid-engagement.
Day-one and subsequent measurement
Instruments issued to related parties, or on terms that differ from what an arm's length lender would require, can produce a day-one gain or loss that has to be identified and explained. Subsequent measurement then requires the fair value at each reporting date, which for an active investor means a repeatable process rather than a one-off report. Where a client carries a portfolio of these instruments, we set up the valuation on a basis that can be rolled forward each period consistently.
Common questions
Do we need to separate the embedded conversion option?
It depends on the terms and on your classification decision. If the embedded derivative is not closely related to the host contract and the whole instrument is not measured at fair value through profit or loss, separation is generally required. Many issuers instead designate the entire instrument at fair value through profit or loss to avoid bifurcation. Both routes need a fair value; the difference is what gets measured and how often.
Our convertible has a conversion price reset. Does that change the model?
Usually yes. A reset tied to future share prices over an averaging window makes the payoff path-dependent, which a standard binomial tree cannot capture correctly. Monte Carlo simulation handles it by generating price paths and applying the reset mechanics along each one. Ratchets, full-ratchet anti-dilution and weighted-average anti-dilution provisions raise the same issue.
How do you set the credit spread for a private company?
By reference to observable market evidence rather than judgement alone: the issuer's own recent borrowings if the terms are arm's length, yields on traded debt of comparable issuers matched on sector, size, leverage and tenor, and where appropriate a synthetic rating derived from financial ratios. The derivation is set out in the report because it is a frequent point of audit challenge.
Can you value the instrument for the holder rather than the issuer?
Yes. Funds, family offices and corporate investors regularly engage us to mark convertible instruments and preference shares they hold, including for quarterly NAV reporting. The modelling is the same; the perspective, the relevant credit risk and the disclosure requirements differ.
Related valuation services
- Share Option & ESOP Valuation
- Expected Credit Loss Assessment
- Startup & Pre-IPO Valuation
- Business Valuation
This page summarises how Valtech approaches this engagement type in Hong Kong. It is general information, not valuation, accounting, tax or legal advice for any specific entity. Scope and methodology are agreed in an engagement letter before work begins.
Request a quotation
Tell us what needs valuing.
Send the basics — entity, purpose, reporting date and standard. A director-level valuer in Kwun Tong will come back with scope, fee and turnaround.