[Derivative ABC] What is 'Mezzanine'?

[Image source=Yonhap News]

[Asia Economy Reporter Ji-hwan Park] Recently, as a series of private equity fund redemption suspensions have occurred, curiosity about mezzanine products is growing. Mezzanine refers to bonds with the right to convert into stocks, such as Convertible Bonds (CB) and Bonds with Warrants (BW).

The word mezzanine comes from Italy. Originally, it means a lounge space between the first and second floors of a building. In the capital market, it refers to investing in CBs and BWs, which are in an intermediate risk stage between bonds and stocks.

In a rising stock market, investors can convert to stocks and gain capital gains, and in a declining market, since they are bonds, they can secure the principal and also benefit from adjustments in the bond exercise price (refixing).

CBs are originally bonds but come with the right to convert into stocks. Investors convert their bonds into stocks to gain capital gains when stock prices rise. If stock prices fall, they can hold the bonds until maturity and receive the agreed principal and interest without selling the stocks.

BW refers to bonds that grant the right to purchase the issuing company's stocks at a predetermined price. If the stock price rises above the base price, investors can buy stocks and make a profit; if not, they can forgo the right and hold only the bonds.

Because mezzanine products grant additional rights to investors compared to regular bonds, their interest rates are generally lower than those of regular bonds. From the company's perspective, they can raise investment funds at a lower interest rate, and from the investor's perspective, although the interest is low, there is an advantage of earning additional income beyond interest. For this reason, many KOSDAQ-listed companies, which generally lack collateral and credit, mainly issue mezzanine products to secure investment funds.

A financial investment industry official explained, "Mezzanine investments often have significantly low liquidity, meaning funds may be tied up for a long time, and the risk of default by the issuing company must be carefully considered. Therefore, selective investment through risk assessment is the most important factor."