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The structure of a convertible resembles that of a traditional corporate bond.
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- Like traditional fixed-income vehicles, convertible bonds have a fixed maturity date at which time the principle is repaid and a fixed coupon that provides annual or semi-annual income payments.
- The holder of the convertible has the right (not the obligation) to convert or exchange the bond, at the investors discretion, into a specified number of shares of the issuers common stock. At this time of conversion, the bondholder simply becomes a holder of common stock, forgoing any future protection, future coupon payments and accrued interest he did as a bondholder. Of course, the investor now has the full advantages of stock ownership (voting rights, dividends, etc.)
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Like equities, convertible bonds provide investors with growth opportunities linked to the performance of the company's stock. The bond's value will increase and decrease with the stock's performance but at various proportions depending on where the convertible is valued at a given time. Convertible trading in the "mid-market" (75%-130% of par) will, over time, capture approximately 2/3's of the stock upside and only participate in approximately 1/3 of the stock's downside. In this "mid-market" area is where the convertible best performs, where the risk/reward opportunity is fully utilized.
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| FEATURES |
- Convertible Bonds are considered corporate Debt obligations.
- Principal amount repaid at maturity. (or in the the event of a call)
- Convertibles pay a coupon income greater than the dividend income of the underlying common stock.
- Convertibles can be converted into a specific number of shares of the underlying common stock, at the discretion of the bondholder.
- Convertibles typically act more like a stock when the underlying equity is appreciating and act more like a bond when the value of the underlying common stock is declining.
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| BENEFITS |
- Relative safety of a bond. (precedence over preferred or common stock)
- Enhanced certainty of minimum return. (yield to maturity/call)
- Provides a vehicle for income oriented investors.
- Offers investors the opportunity to participate in the growth potential of a common stock.
- Can offer superior risk/reward opportunities relative to outright ownership of the common stock.
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Convertible bonds generally trade with lower yields than traditional bonds of comparable credit quality and maturity. Conversley, convertibles typically offer greater income than the dividend yield of the underlying stock.
The bondholder is able to benefit from an increase in the bond's underlying stock price, even if the investor doesn't convert into a common stock. The price of these bonds not only reflects the current value on converting into common stock, but also the potential for gaining value through future conversion.
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