Convertible Securities
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A convertible security (sometimes referred to simply as CV) is a convertible bond or a preferred share/stock convertible. In the case of a convertible bond, it is a type of bond that can be converted into the company's common stock meaning that as a holder of a convertible bond, you can exchange the bond for a pre-agreed number of shares in that particular company. The actual number of shares that you can get for the bond you own is obviously dependent on the company that has provided the bond but you will always be able to find the terms of the bond, for example the amount of shares you can get in the indenture. This will usually be shown as a conversion ratio rather than a particular number, for example a conversion ration of 30:1 would mean that for every bond (with a ÂŁ1000/$1000 value) could be converted into 30 shares of that particular company.
One risk that comes with convertible bonds is that most are redeemable bond, meaning that the issuing company of the bond can redeem it before it reaches maturity whether the owner wants to do this or not. The name given to this is a forced conversion and when investing in convertibles, it is important to remember that the bond you are purchasing is only as valuable and trustworthy as the company you are purchasing it from. Unfortunately but predictably, it is the riskier companies that are offering the higher premiums on the bonds and similarly the more stable the company the lower the risk but also the lower the reward. The best way of looking at it is that if you wouldn’t want to own the stock, you wouldn’t want to own their bonds.
Issuing convertible bonds is one tactic that larger companies use to decrease the negative public and investor opinion of it’s corporate actions. One example of this would be that in the event that a company that is already listed on the stock exchange may sometimes decide to issue additional shares which is generally seen by investors as a sign that the existing shares are overvalued. However, if they were to issue convertible bonds they would be able to avoid this negative opinion, they will get the cash injection that they require and if the company shares continue to do well it is likely that the owner of these bonds will convert them into shares anyway.
From the investor's point of view, a convertible bond is essentially a relatively secure bond with a reasonable return on investment, but with the addition of a stock option as well. Thus, it tends to offer a lower rate of return in exchange for the value of the option to trade the bond into stock. A convertible note (or, if it has a maturity of greater than 10 years, a convertible debenture) is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price. It is a hybrid security with debt- and equity-like features. Although it typically has a low coupon rate, the instrument carries additional value through the option to convert the bond to stock, and thereby participate in further growth in the company's equity value. The investor receives the potential upside of conversion into equity while protecting downside with cash flow from the coupon payments.
One risk that comes with convertible bonds is that most are redeemable bond, meaning that the issuing company of the bond can redeem it before it reaches maturity whether the owner wants to do this or not. The name given to this is a forced conversion and when investing in convertibles, it is important to remember that the bond you are purchasing is only as valuable and trustworthy as the company you are purchasing it from. Unfortunately but predictably, it is the riskier companies that are offering the higher premiums on the bonds and similarly the more stable the company the lower the risk but also the lower the reward. The best way of looking at it is that if you wouldn’t want to own the stock, you wouldn’t want to own their bonds.
Issuing convertible bonds is one tactic that larger companies use to decrease the negative public and investor opinion of it’s corporate actions. One example of this would be that in the event that a company that is already listed on the stock exchange may sometimes decide to issue additional shares which is generally seen by investors as a sign that the existing shares are overvalued. However, if they were to issue convertible bonds they would be able to avoid this negative opinion, they will get the cash injection that they require and if the company shares continue to do well it is likely that the owner of these bonds will convert them into shares anyway.
From the investor's point of view, a convertible bond is essentially a relatively secure bond with a reasonable return on investment, but with the addition of a stock option as well. Thus, it tends to offer a lower rate of return in exchange for the value of the option to trade the bond into stock. A convertible note (or, if it has a maturity of greater than 10 years, a convertible debenture) is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price. It is a hybrid security with debt- and equity-like features. Although it typically has a low coupon rate, the instrument carries additional value through the option to convert the bond to stock, and thereby participate in further growth in the company's equity value. The investor receives the potential upside of conversion into equity while protecting downside with cash flow from the coupon payments.
