Overhanging bonds

Overhanging bonds

An overhang refers to the possible dilution of the value of equity investments due to stock options that are about to be converted to equity shares. The dilution impacts earnings per share and return on investment per share. Overhanging bonds are a market phenomenon that arise when many bonds from a single issuer go unsold or untraded. Overhanging bonds are relevant to market participants because they affect bond prices, liquidity, and trading dynamics. Overhanging bonds can provide insights into market mood and prospective investment opportunities if monitored and analysed. 

What are overhanging bonds? 

An overhanging bond is a market situation in which a substantial supply of bonds from a single issuer remain unsold or untraded. This excess supply puts downward pressure on bond prices while raising bond yields.  

Overhanging bonds usually emerge when market demand is insufficient to absorb the supply, which can be caused by changes in investor sentiment, issuer-specific concerns, or market conditions. Investors watch overhanging bonds because they can affect the pricing and liquidity of existing bonds in the market. Market participants must consider overhanging bonds when evaluating investment opportunities and controlling risk. 

Understanding overhanging bonds 

Overhanging bonds are bonds that stay unsold or untraded in the bond market due to a massive supply of bonds from a given issuer. The presence of overhanging bonds puts downward pressure on bond prices and upward pressure on bond yields because investors may be hesitant to purchase the surplus supply of bonds, resulting in lower prices to entice purchasers.  

The excess supply also impacts bond liquidity and trading activity. Market participants widely monitor overhanging bonds because they might provide insights into market mood and affect investing plans. The overhanging bond issue can be often resolved by restoring investor confidence or changing market circumstances to absorb excess supply. 

How do we have overhanging bonds? 

Overhanging bonds are the result of an imbalance in the bond market’s supply and demand. A substantial quantity of unsold or untraded bonds generates a market overhang. Changes in investor mood, issuer-specific concerns, or market conditions can all contribute to this surplus supply.  

Bond prices are pushed lower by overhanging bonds, while bond yields are pushed upward because investors may be hesitant to acquire the surplus supply of bonds, causing prices to fall and yields to rise to entice buyers.  

Overhanging bonds can impact the pricing and liquidity of existing market bonds. Investors frequently monitor overhanging bonds because they can provide insights into market conditions and impact investment decisions. 

How do we find if there are overhanging bonds? 

The following steps should be followed to calculate if there are overhanging bonds: 

  • Begin by determining the total number of bonds issued by the specified issuer. This information is typically provided in the bond prospectus or financial statements. 
  • Determine the number of bonds that have previously been sold and are actively trading in the market. This information can be collected through market data sources or financial reports. 
  • Subtract the entire supply of bonds from the total supply of outstanding bonds. The outcome will offer you the number of bonds regarded as overhanging, i.e. the surplus supply. 

Example of overhanging bond 

Company XYZ intends to issue 10,000 bonds with a face value of US$1,000 each, for a total supply of US$ 10,000,000 in bonds. However, due to market conditions, investor mood, or issuer-specific issues, only 6,000 bonds have been sold and are actively trading in the market. 

Overhanging bond = Total supply of bonds – outstanding = 10,000 – 6,000 

Overhanging bond = 4,000 bonds 

In this situation, there are 4,000 overhanging bonds, which reflect the surplus supply of bonds that have yet to be sold or traded in the market. This excess supply may put downward pressure on bond prices and upward pressure on bond yields, altering the pricing and liquidity of existing bonds. 

Frequently Asked Questions

Stock overhang is the term used to describe an oversupply of a specific stock on the market, which pushes its price lower. It occurs when a few stockholders own a significant block of stock shares, increasing the likelihood of a price drop if they sell them all at once.  

This may occur for various reasons, including when a major institutional investor decides to sell a sizable amount of his holdings or when a business sells new shares through a secondary offering.  

Due to the imbalance between supply and demand, the stock overhang can negatively affect the stock’s price performance. Investors carefully watch for a stock overhang since it might indicate possible selling pressure and affect their investing choices. 

A bearish overhang in the financial markets refers to a situation in which there is a negative feeling or anticipation regarding the future direction of a certain asset or market. It is marked by an excess supply of sellers eager to sell their assets at cheaper prices, causing the price to fall. Poor economic data, geopolitical conflicts, or unfavourable news about a certain firm or industry can all contribute to this gloomy feeling. A negative overhang can lead to a lengthy period of dropping prices, making it difficult for investors wanting to acquire or keep assets in such a market. 

Risk overhang in insurance refers to situations where an insurer’s continued exposure to prior transactions limits its current activities. It is typically when an insurance company must decline lucrative prospects because it cannot accept any additional risk. 

This risk overhang can be caused by various circumstances, including changes in policy terms and conditions, market conditions or even unforeseeable occurrences that may increase claims. Insurers must cautiously monitor risk overhang to maintain appropriate reserves and reinsurance coverage for future claims. Failure to do so may result in the insurance company’s financial instability and potential bankruptcy. 

Some factors to examine while considering overhanging bonds include the issuer’s creditworthiness, current interest rates, maturity date, call provisions, bond rating, liquidity, market conditions, inflation expectations, and any unique features or covenants associated with the bond. 

Overhang is calculated by dividing the total amount of outstanding stock by the number of present and future option offerings.  

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