Convertible Bonds
Convertible bonds are corporate bonds that can be converted into a predetermined number of the issuer's common stock. They offer investors the potential for capital appreciation if the stock price rises, while also providing downside protection through the bond's fixed-income characteristics. This hybrid nature makes convertible bonds an attractive investment option for both bond and equity investors.
6 Key excerpts on "Convertible Bonds"
- Thomas Herold(Author)
- 2020(Publication Date)
- THOMAS HEROLD(Publisher)
...What is a Convertible Bond? A convertible bond is like a hybrid between a stock and a bond. Corporations issue these bonds which the bondholders may choose to convert into shares of the underlying company stock whenever they decide. Such a bond usually pays better yields than do shares of common stocks. Their yields are also typically less than regular corporate bonds pay. Convertible Bonds provide income to their investors just as traditional corporate bonds do. These convertibles also possess the unique ability to gain in price if the stock of the issuing company does well. The reasoning behind this is straightforward. Because the bond has the ability to be directly converted into stock shares, the security’s value will only gain as the stock shares themselves actually rise on the market. When the stock performs poorly, the investors do not have the ability to convert the convertible bond into shares. They only gain the yield as a return on the investment in this case. The advantage these bonds have over the company stock in these deteriorating conditions is significant. The value of the convertible instrument will only drop to its par value as long as the company that issues it does not go bankrupt. This is because on the specified maturity date, investors will obtain back their original principal. It is quite correct to say that these types of bonds typically have far less downside potential than do shares of common stocks. There are disadvantages as well as advantages to these Convertible Bonds. Should the issuer of the bond file for bankruptcy, investors in these kinds of bonds possess a lower priority claim on the assets of the corporation than do those who invested in debt which was not convertible. Should the issuer default or not make an interest or principal payment according to schedule, the convertibles will likely suffer more than a regular corporate bond would...
eBook - ePubIntroduction to Fixed Income Analytics
Relative Value Analysis, Risk Measures and Valuation
- Frank J. Fabozzi, Steven V. Mann(Authors)
- 2010(Publication Date)
- Wiley(Publisher)
...CHAPTER 10 Analysis of Convertible Bonds Corporations must fund their operations by selling claims to the expected future cash flows they generate. The two basic claims issued are debt and equity. Debt claims are fixed by contract; equity claims are residual. Between these two endpoints, there exists a continuum of securities that possess features of both debt and equity. Among the most prominent of these hybrid securities is Convertible Bonds. A convertible bond is a combination of an option-free bond and the option to convert the bond into a given number of shares of the issuer’s common stock. Convertible Bonds are typically callable and may be putable. Depending on the performance of the underlying stock, a convertible bond may behave more like a common stock or more like an option-free bond. In its most basic form, a convertible bond represents a combination of an option-free bond and call option on the underlying common stock. Specifically, a convertible bond is a security that gives the investor the option to convert into a specified number of shares (adjusted for stock splits/stock dividends) of the issuer’s common stock. This differs from an exchangeable bond, which gives investors the option to exchange their bond for the common stock of a firm other than the issuer. Valuation of convertibles presents some challenges to the analyst. For example, the exercise price for the conversion option is surrendering a bond whose price changes. Moreover, Convertible Bonds issued today typically possess more than one embedded option. As noted above, these bonds can be callable and/or putable...
eBook - ePubThe Handbook of Traditional and Alternative Investment Vehicles
Investment Characteristics and Strategies
- Mark J. P. Anson, Frank J. Fabozzi, Frank J. Jones(Authors)
- 2010(Publication Date)
- Wiley(Publisher)
...A convertible security, or simply a convertible, can be a convertible bond or a convertible preferred stock. In our discussion of convertibles, we will focus on Convertible Bonds. Convertible Bonds issued today typically possess more than one embedded option in that they can be callable and putable. Accordingly, the value of a Convertible Bonds depends on: (1) how interest rate changes impact the bond’s expected future cash flows via call and/or put options; (2) how creditworthiness of the underlying company impacts expected future cash flows; (3) how changes in the issuer’s common stock price impact the value of the conversion feature; and (4) how volatile the common stock price is. In its most basic form, there are two equivalent ways to describe a convertible bond. First, a convertible bond represents the combination of an option-free bond and call option on the common stock. However, unlike the exercise price of a call option, which is fixed, the value of the bond is surrendered to obtain a predetermined number of shares of common stock. Second, a convertible bond is a combination of common stock and a put option, which gives the bondholder the right to sell the stock back to the issuer with an exercise price equal to the market value of the convertible. If the investor chooses not to convert, this decision effectively exercises the put and thereby the investor keeps receiving the bond’s cash flows. Closely related to a convertible bond is an exchangeable bond. An exchangeable bond gives the bondholder the right, but not the obligation, to exchange the bond for the common stock of a firm other than the bond issuer. For example, in April 2007, UBS AG issued 6% six-month notes that were exchangeable into a fixed number of shares of Honda Motor Corporation. The same guidance in assessing the appeal of a convertible bond applies to an exchangeable bond...
- Juan Ramirez(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...3 Convertible Bonds and Mandatory Convertible Bonds This chapter examines the major characteristics of Convertible Bonds and mandatory Convertible Bonds. It covers the terminology, structures and price behavior of these instruments, as well as issuer and investor motivations. Also in this chapter, contingent convertibles – FRESHES, CASHES and ECNs – are covered in detail. Several real case studies are included: a convertible bond issued by the German corporate Infineon, a mandatory convertible bond issued by UBS, a FRESH issued by Fortis Bank, a CASHES issued by Unicredit and an ECN issued by Lloyds. 3.1 INTRODUCTION TO Convertible Bonds 3.1.1 What are Convertible Bonds? Convertible Bonds are instruments which give the holder the right to “convert” a bond into a fixed number of the issuer's common stock (i.e., ordinary shares) at a specified price. Convertible Bonds have both common stock and straight bond features. Like common stock, convertible bond holders benefit from an appreciation of the issuer common stock. Like straight bonds (i.e., non-Convertible Bonds), Convertible Bonds can have cash redemption at maturity and fixed coupon payments. In this way, Convertible Bonds reflect a combination of the benefits of stocks and those of bonds (see Figure 3.1). Figure 3.1 Comparing a convertible bond with common shares and a straight bond. Commonly, Convertible Bonds tend to pay lower coupons than straight bonds because their holders also participate in the underlying stock appreciation. However, Convertible Bonds can be tailored to meet an issuer's specific coupon requirements. For example, a convertible bond can be structured to look more like a bond with a high coupon and a high conversion premium, or more like equity, with a low coupon and a low conversion premium. The higher the coupon, the lower the probability of being converted into shares. The lower the conversion price, the higher the probability of being converted into shares...
eBook - ePub- Paul Wilmott(Author)
- 2013(Publication Date)
- Wiley(Publisher)
...In the long term, if they are successful, they will hand over shares to happy investors. On the other hand, CBs can be issued by more speculative firms who would then be tempted to take risks with the capital so raised. What is their downside? The convertible bond has characteristics that make it sometimes behave like stock, and sometimes like a bond. The conversion feature of Convertible Bonds also makes these contracts similar to American options. The question of when to exercise an American option is very similar to the question of when to convert a convertible bond. It is this ‘optionality’ that adds value to the convertible bond. CBs are different from options, however, in that on conversion, new shares are issued. The CB is an example of a hybrid instrument since it has features of both equity and debt. 33.2.2 The Issuers of CBs CBs are issued by corporations. These companies are often not of the highest quality, in terms of credit risk. By selling bonds which can be later converted to equity the issuer can get away with a lower coupon than might otherwise be expected. 33.2.3 Why Issue a Convertible? Corporations in need of capital have many choices available to them. These choices have two common themes: Issue equity; Issue debt. Issue equity: Dilutes earnings per share but has low initial financing costs. Issue debt: Does not dilute earnings per share but may have high initial financing costs. The other possibility is to issue a hybrid instrument with both of these features: The Convertible Bond. The bond can be sold with a lower coupon than a plain bond with the same maturity and price. (Or equivalently, it can be sold for a higher price with the same coupon.) It does not dilute earnings per share, until the bond is converted and new shares are issued. If the bond is converted, the principal does not have to be repaid. The typical issuer of CBs has high cash requirements, perhaps with a very rapid use of cash and low credit quality. They may be startups...
eBook - ePubIslamic Capital Markets
The Structure, Formation and Management of Sukuk
- Imam Uddin, Rabia Sabri, M. Ishaq Bhatti, Muhammad Omer Rafique, Muhammad AsadUllah(Authors)
- 2022(Publication Date)
- Routledge(Publisher)
...the interest value) which remains fixed throughout the pre-determined life of a financial bond. Zero-Coupon Bonds: These types of financial bonds have no fixed coupon value associated with them, and this coupon value is expected to be rolled up as the bond approaches its maturity date. Moreover, these bonds can be sold out in such a way that their coupon value and original bond value could be traded separately. Asset-Backed Bonds: These are types of conventional bonds in which coupon value (i.e. interest) and face amount (i.e. principal amount) are subject to be associated or backed up with the underlying cash flows from other assets and their values. Treasury Bonds: These types of financial bonds are also known as government bonds with the lowest interest rates since they are only issued by the legal state-owned financing authorities. Corporate Bonds: These are typically the type of bonds, which are issued by private corporations which seek to raise their capital for corporate expansion. Convertible Bonds: These types of conventional bonds can be converted into shares of common stock or cash under the maturity period, at a mutually agreed value between issuer and holder. Linker Bonds: These types of conventional bonds have their face amount and coupon value associated with the variable inflation rate. Perpetual Bonds: These are special types of conventional bonds which have no particular maturity date associated with them. Subordinated Bonds: These types of conventional bonds are identified by the feature that their priority becomes low at the time of liquidity of its issuer. Conventional Bonds and Sukuks At this stage, it should be clarified in a succinct manner that what are the core differences between conventional financial bonds and Sukuk certificates, except that the second one does not employ Riba in its structural identity...
