Delving into the bonds market: The ins and outs of convertible bonds

Julie Brownlee, Fsp Invest, 02 Jan. 2015

Tags: convertible bonds, what are convertible bonds, how convertible bonds work, bonds, bond market, conversion premium,

Convertible bonds work in much the same way as conventional bonds do, but with an added extra.

So what exactly are convertible bonds? And what are the advantages of investing in them?

Read on to find out…

What are convertible bonds?

A convertible bond works in a similar way to a conventional bond.

It pays a fixed amount of interest each year and comes with a promise to pay back your original investment at the end of the bond’s life.

But with convertible bonds you have the chance to convert your bonds into shares. This option only arises if the share price rises above a pre-set level before a specific date.

This is the ‘conversion price’.

The advantages of investing in convertible bonds

Convertible bonds offer investors the safety associated with investing in bonds, with the option to profit if the share price rises a lot. Conservative investors often target this type of bond because of this.

If the share price doesn’t perform well or falls, you should still receive the interest payments and your initial investment back when the bond matures.

Convertible bonds in action

Company ABC issues a five-year convertible bond. It matures in December 2019.

It pays an annual interest rate of 1.5% on its initial (par) value. The conversion price is 700c.

This conversion price (or conversion premium) was 30% higher than the company’s share price when it issued the bond.

This conversion premium protects existing shareholders from an issue of new shares, which would dilute their holding in the company. So the shares have to rise by this amount before converting the bond is worthwhile.

So there you have it, the ins and outs of convertible bonds.

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