A bond, for example, has a conversion ratio of 5, meaning that one bond can be exchanged for five shares of common stock. The price of the bond divided by the conversion ratio is the convertible security’s conversion price. If the bond’s par value is $1000, the conversion price is $200, which is found by multiplying $1000 by 5. The conversion price reduces to $100 if the conversion ratio is ten. As a result, for the security to be converted, the market price must catch up to the conversion price. A lower conversion ratio leads to a lower conversion price, whereas a greater conversion ratio leads to a higher conversion price.
How do you go about purchasing convertible bonds?
Convertible bonds can be purchased in a variety of ways. Individual bonds can be purchased through a brokerage that has a bond desk and a convertibles specialist. Convertibles, on the other hand, aren’t widely available, thus many brokerages don’t provide direct investments in them.
If you wish to invest directly, do your homework first. Before making any judgments, go over the bond contract, examine the credit ratings, and learn everything you can about the company.
Many investing businesses offer mutual funds and exchange-traded funds (ETFs) that invest in convertible bonds as an alternative. Almost any investor can find something that suits them. However, keep in mind that these funds are often connected with stock market performance and may look similar to equities funds, albeit with a larger dividend yield.
Convertible bonds are issued by which companies?
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.
How do you determine the bond floor?
Calculate the present value (PV) of the coupon and principal payments discounted at the straight bond interest rate to find the bond floor. Even if the stock price of the company decreases, the convertible bond should sell for at least $884.18.
Who can purchase convertible bonds?
Convertible bonds are a type of hybrid security that has the characteristics of both bonds and stocks in terms of return. Convertible bonds can be exchanged for a specific number of shares of the issuer’s common stock. Individual convertible bonds should be obtained through a broker with a convertible bond desk. Closed end funds, or CEFs, provide the best chance for do-it-yourself investors to invest in convertible securities.
When will I be able to purchase convertible bonds?
Convertible bonds are preferred by businesses because the interest rates are cheaper than nonconvertible debt. This feature appeals to businesses who are expanding in sales but have yet to earn a profit. Bondholders want higher interest rates since the danger of default is higher for a corporation that has suffered losses.
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 is a convertible bond’s straight bond value?
- The issuer pays the convertible bond holder a periodic interest payment known as a coupon. It could be either constant or variable, or it could be zero.
- Maturity/redemption date: The date on which the bond’s principal (par value) and any outstanding interest must be paid. There is no maturity date for non-vanilla convertible bonds in some situations (i.e. permanent), which is common with preferred convertibles (e.g. US0605056821).
- Final conversion date: The last day on which the holder can request a share conversion. It’s possible that this date differs from the redemption date.
- If the bond offers a premium redemption, the yield on the convertible bond at the issuance date may differ from the coupon value. In those instances, the premium redemption value and intermediary put redemption value would be determined by the yield value.
- The value of a convertible bond’s fixed income aspects (regular interest payments, payment of principal at maturity, and a superior claim on assets relative to common stock) minus the capacity to convert into shares is known as the bond floor.
- Either a conversion ratio or a conversion price will be stated in the issue prospectus. When an investor exchanges a bond for common stock, the conversion ratio is the number of shares received. When exchanging a bond for common stock, the conversion price is the price paid per share to obtain the shares.
- The price that a convertible investor effectively pays for the right to convert to common stock is known as the market conversion price. It’s calculated in the following way. Once the underlying stock’s actual market price reaches the market conversion price incorporated in the convertible, every additional increase in the stock price will push up the convertible security’s price by at least the same proportion. As a result, the market conversion price serves as a “break-even point.”
- The difference between the market conversion price and the current market price of the underlying stock is known as the market conversion premium. Convertible bond buyers accept a conversion price in return for the fixed income characteristics of a convertible bond, which give downside protection. The price of the convertible bond will not fall below the bond floor value as the stock price falls. The market conversion premium is calculated as follows, usually on a per-share basis:
- Parity: The immediate value of a convertible if it is converted, calculated by multiplying the current stock price by the conversion ratio given in terms of a base of 100. Exchange Property is another name for it.
- Call features: The issuer’s capacity (on some bonds) to call a bond for redemption early. This is not to be confused with a call option. A softcall is a call feature in which the issuer can only make a call under specific conditions, usually dependent on the underlying stock price performance (e.g. current stock price is above 130 percent of the conversion price for 20 days out of 30 days). A Hardcall feature would not require any restrictions beyond a deadline: the issuer would be free to recall a portion or the entire issuance at the Call price (usually par) after a deadline.
- Put features: The capacity of the bond’s holder (lender) to compel the issuer (borrower) to repay the loan before the maturity date.
- Every three or five years, these appear as windows of opportunity, allowing holders to use their right to an early payback.
- Convertible bondholders’ capacity to convert into equity is limited by contingent conversion (also known as CoCo). Restrictions are typically based on the underlying stock price and/or time (e.g. convertible every quarter if stock price is above 115 percent of the conversion price). In that regard, reverse convertibles could be viewed as a variant of a Mandatory with a contingent conversion clause. Some CoCo issuances in recent years have been based on Tier-1 capital ratios for some significant bank issuers.
- Reset: Depending on the performance of the underlying stock, the conversion price will be reset to a new value. In most circumstances, this would be in the event of poor performance (e.g. if stock price after a year is below 50 percent of the conversion price the new conversion price would be the current stock price).
- Change of control event (aka Ratchet): In the event of a takeover of the underlying company, the conversion price would be recalculated. There are several types of ratchet formulas (e.g., Make-whole base, time dependant…), and their influence on bondholders can range from minor (e.g., ClubMed, 2013) to considerable (e.g., ClubMed, 2013). (e.g. Aegis, 2012). This clause sometimes includes the power for convertible bondholders to “put,” or request an early return of their bonds.
- Non-dilutive: With reduced interest rates (e.g. in the Euro), the non-dilutive feature has become more common, making convertible issuance remain appealing to issuers who already benefit from low interest rates in the straight bond market. The issuer would simultaneously enter into an OTC option agreement with the underwriter in a non-dilutive placement (or a third party). This option would frequently match the convertible’s strike as well as its maturity. If the stock price is above the strike, this will cancel out the dilution in the case of a convertible conversion at maturity. Typically, the convertible prospectus would limit the potential of early conversion to entirely prevent dilution.