Convertibles are stealing the show with their safe investment image in today’s ‘protective” market. They seem to be overshadowing the stocks and bonds. This holds true for the mediocre issuers.
A convertible bond, as the name suggests, can be transformed into a company’s common stock. The bonds are a matter of additional profit for the investors. Although investors are particular about short-term performance of stocks, they are upbeat about a long-term, fixed-income instrument that gives them profit on converting to common stock, if the stock price soars within a wide range of 20 to 40 percent.
Way Too Much Information On Convertible Securities
Convertible preferred stocks are very similar to convertible bonds that can be transformed into a common stocks under certain specified conditions, sometimes at a certain price or a time period.
Were you aware of that?
Warrants is a way to provide the owner to purchase a firm’s common stock during a specific time period at a certain price which is commonly called the exercise price or strike price.
Why the sudden craze for convertibles? The main reason is the strong will of the investors for ‘safe” instruments to lock up their precious life savings into. And the issuers have been smart enough to grab this lucrative opportunity. A few years back, liquid issuers—considered to be the stalwarts of the market—were ruling the roost in the convertible bond market, with the average value of a convertible issue touching $300 million to $350 million. But today, nearly nine convertibles have a whopping size of a billion dollars and one has even crossed the $3 billion mark. The fall in stock prices and the frequent quivers in the credit markets have established a strong wave of demand for convertibles.
A convertible bond is issued at a strike price, 25 to 40 percent more than the market price of the general stock made by the company. The convertible bond has a 7-year maturity period and can be called after three years. The issuer can call the bond, if the market price exceeds the strike price. But if the strike price manages to remain high till maturity, the investors have two options: they can either get back the par value of the bond, or convert it to common stock. However, in the event of a mandatory convertible, there is no choice—the bond has to be converted to common stock.
Convertible bonds are legally debt securities. These are above all equity securities in a default situation. Similar to other bonds, their value is also affected by the existing interest rates and the credit worthiness of the issuers. However, convertibles have opened two ways for the investors to earn dollars. One way is by selling the convertible bond when its price soars in the market. The other way is by converting the bond to common stock and selling the shares.
The best way for an individual investor to indulge in the convertible bonds business is buying a mutual fund. This is because convertibles are complex securities and, unlike common stocks, it’s tough for beginners to get all the information about them. Hence, the investors should check out certain things before buying a convertible bond. These are: the interest rate and performance of the bond, the number of years prior to maturity, the common stock price during conversion of the bond, characteristics of the bond that make it distinct from the negative aspects of the bond, a usual bond, and the benefits while converting to a common stock.
The investors should also inquire about the company that is issuing convertibles besides this. Any bond, either convertible or the general one, is a loan. Hence, the investors should see to it that their issuer has the ability to pay back what they owe. Therefore, going for a convertible bond demands an extensive homework on the portion of the investor.
When we compare convertible bonds to convertible preferred stocks, the former are safer. There are two reasons for following: the interest on convertible bonds is paid before any stock dividends, and, if the company suffers a loss, the investors of convertible bonds have an upper hand over the investors of stocks while claiming the money.
However, it’s not prudent to get carried away by the benefits of convertibles. Firstly, convertible funds happen to be costlier than domestic stock funds, as the former come packed with sales charges. Secondly, a majority of the convertibles are issued by companies involved in technology and telecommunications. These are characterized by unpredictable markets. And lastly, convertible bonds do not guarantee a risk free investment just because they’re convertible.