The sale of CBBCs by issuers is similar in nature to the provision of a margin facility (in the case of bulls) and lending stocks for a short sale (in the case of bears), hence the issuer charges certain funding costs for hedging against their own costs. Methods to calculate funding cost vary with different borrowing rates used by the issuers.
In practice, since the issuer cannot collect the funding cost from investors holding the CBBCs on a daily basis during the holding period, the issuer will first take into account all the funding cost up until the expiry date when calculating the CBBC price, and then gradually deduct it over time. If an investor sells a CBBC before expiry, he can recover the un-deducted funding cost from the issuer.
Some investors may compare the deduction of funding cost for a CBBC with the time decay of a warrant. However, the two are not the same concept. In addition, the funding cost of a CBBC only accounts for a very small part of the price, while time decay accounts for a large part of the value of a warrant, and even the total value of an out-of-the-money warrant. The impact of the deduction of time decay on the price of a warrant is much more apparent than the impact of the deduction of funding cost on a CBBC.
“When Issuers sold CBBCs, it is very similar to provide margin financing services (Bulls), or Stock lending for short selling. Issuer will charge a funding cost on the product as the fee for the compensating the hedging cost.”