What Is Liquid Yield Option Note (LYON)?

Liquid yield option notes (LYONs), introduced by Merrill Lynch in 1985, are a form of zero-coupon convertible bonds with a predetermined conversion feature that allows either the holder or issuer to convert them to a fixed number of shares of common stock.

Key Takeaways

  • Liquid yield option notes (LYONs), introduced by Merrill Lynch in 1985, are a form of zero-coupon convertible bonds.
  • LYONs have a predetermined conversion feature that allows either the holder or issuer to convert them to a fixed number of shares of common stock.
  • LYONs are callable, which gives the issuer the right to buy them back, and putable, which gives the holder the right to sell it back.

Understanding Liquid Yield Option Notes (LYONs)

LYONs are zero-coupon bonds. These bonds are convertible, callable, which gives the issuer the right to buy them back, and putable, which gives the holder the right to sell it back. These three qualities, along with the fact that they offer no coupons, made them a financial innovation at introduction.

LYONs are considered a synthetic instrument. Being a synthetic vehicle means that they have a structure which simulates the cash flow of other financial instruments. The convertible feature allows them to be converted into a predetermined amount of the underlying company's equity at certain times during the bond's life, usually at the discretion of the bondholder. The put nature of the LYON allows the bondholder to force the issuer to repurchase the security at specified dates before maturity. The repurchase price is set at the time of issue and is usually at par value.

While the convertible and put features awards the investor, the callable feature awards the issuer. A callable bond is one that can be called for redemption by the issuer before it matures. Issuers generally tend to redeem bonds prematurely if interest rates dip and they could save money by redeeming bonds immediately. When redemption of a callable bond happens before maturity, it will pay a pre-determined price based on its current age.

The zero coupon LYON will not give the investor a regular flow of income. A zero-coupon bond is a debt security that doesn't pay interest or coupon. It is usually offered at a deep discount and renders its profit at maturity with redemption at full face value.

Liquid Yield Option Note (LYON) Issuers

Merrill Lynch engineered and served as the primary underwriter for LYONs, but other corporations sold them. For this reason, if an investor chose to convert their LYON to common stock, they would be turning it into stock shares in the company that issued the bond and not Merrill Lynch. Some of the well-known companies that issued LYON through Merrill Lynch included Eastman Kodak, American Airlines, Motorola, and Marriott. Once the conversion of a LYON to stock is complete, the holder is entitled to all of the rights and dividends of a regular stockholder in that company.