- Because the investor can reclaim their original investment when the bond expires, the risk is minimal.
- Convertible bonds can help diversify a portfolio by lowering risk while preserving projected returns.
- Convertibles provide a higher rate of return than regular corporate bonds, and the investor can convert to take advantage of stock price gains.
- Convertibles can improve returns in a fixed income portfolio by providing exposure to equity-driven price gains while also reducing the impact of rising interest rates.
- Convertible bonds can help decrease negative risk in a stock portfolio without sacrificing all upside potential.
- Bondholders are paid before stockholders, thus investors have some protection against default before the conversion.
Why are investors drawn to convertible bonds?
Convertible bonds are appealing because the fixed income component (i.e., the investment value) of the convertible bond functions as a support level below which the convertible bond will not fall as the stock price declines.
Is it wise to invest in convertible bonds in 2021?
In 2021, the average interest coupon on convertible debt will be 1.41 percent, which is the lowest ever. According to Dealogic, this year’s crop of issuers will only need to convert bonds into stock if their share price grows 39 percent in five years on average, the largest conversion premium since 2003.
Convertible bonds allow you to lose money.
Convertible bonds offer a higher potential for gain than corporate bonds, but they are also more exposed to losses if the issuer defaults (or fails to make its interest and principal payments on time).
Key Points
- A convertible bond is a form of bond that the holder can exchange for shares of the issuing company’s common stock or cash of equal value at a predetermined price.
- Convertible preferred stocks are securities with a clause that allows the holder to convert the preferred into the company’s common stock under specific circumstances.
- The simultaneous acquisition of convertible securities and the short sale of the same issuer’s common stock is known as convertible arbitrage.
- When the stock price is higher than the amount that would be paid if the bond were redeemed, forced conversion happens.
When is the best time to buy convertible bonds?
A vanilla convertible bond gives investors the option of holding the bond until it matures or converting it to stock. If the stock price has fallen after the bond was issued, the investor can keep the bond until it matures and receive the face value. If the stock price rises sufficiently, the investor can convert the bond to stock and choose whether to hold or sell the stock. When the gain from the stock sale surpasses the face value of the bond plus the total amount of remaining interest payments, an investor should convert the bond to stock.
Companies issue convertible bonds for a variety of reasons.
- Convertible bonds are corporate bonds that can be exchanged for the issuing company’s common stock.
- Convertible bonds are issued by companies to cut debt coupon rates and defer dilution.
- The conversion ratio of a bond decides how many shares an investor will receive in exchange for it.
- Companies can force bond conversion if the stock price is higher than the bond’s redemption price.
What corporations have convertible bonds on the market?
Convertible bond issuance is on the rise, as companies such as Airbnb, Ford Motor Company, Spotify Technology, and Twitter take advantage of high investor demand for low-cost capital.
Are there any decent convertible mutual funds?
Is it a good idea for private investors to look into convertible debt? According to my research, the answer appears to be “yes,” at least risk-adjusted.
Most investors can acquire convertible bonds through mutual funds and exchange-traded funds, which are a debt/equity hybrid that performs well when markets rise and retains some of its value when markets collapse. I looked analyzed the returns of all dollar-denominated convertible debt ETFs and mutual funds over the last 15 years alongside Daniel Arguedas-Cornejo and Emily Baucom (research assistants at George Mason University).