How does “funding cost” affect the price of a CBBC and how is it calculated?

The funding cost of a CBBC is relevant to determining its price. A CBBC is generally traded at a price that represents:

(a) for bull CBBC, (spot price or level of the underlying asset - strike price or level of the CBBC) + prevailing funding cost; and

(b) for bear CBBC, (strike price or level of the CBBC - spot price or level of the underlying asset) + prevailing funding cost.

The funding cost is determined based on:

(a) an issuer’s financing or stock borrowing costs, after adjustment for any expected ordinary dividends of the shares (if the underlying assets are dividend-paying shares); and

(b) its profit margin.

These items fluctuate from time to time. The funding cost of a CBBC may be affected by its supply and demand. Furthermore, depending on the liquidity and volatility of the underlying asset at the time, the cost and risk of hedging may also cause a fluctuation in the issuer’s funding costs. This means that the issuer’s funding costs are not fixed throughout the term of the CBBC. In addition, the longer the duration of the CBBC, the higher the funding costs. The funding costs decline over time as the CBBC moves towards expiry.

When choosing between CBBCs, amongst other considerations, you should compare the funding costs of different issuers of CBBCs with similar underlying assets and features.