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What are Convertible Bonds?

Average returns7.30%

Average Yield7%

Min. Investment₹10,000

What are Convertible Bonds?

A convertible bond is a good source of fixed income. The investors get interest payments until the bonds are converted into equity shares. It is comparatively safe and provides higher yields than common stock.

Types of Convertible Bonds

The vanilla convertible bond is issued with a conversion price which is the price that the underlying stock must achieve for making the conversion profitable. The issue of the convertibles is in higher prices that are much higher than the underlying stock price. If the bond is converted, the unpaid accrued interest of the investor stands forfeited. Because of this, investors usually wait until entitled to the next interest payment before converting the bond into stock.

Convertibles have a call and put option embedded over it. A call option provides the right to the issuer to vigorously redeem the bonds before maturity for a pre-fixed price. The call date is often staggered across many years after the issue date. Call options do not appeal to investors, who need additional yield above the yields on basic convertibles or vanilla. Put options provide the investor the authority to sell the bond back to the issuer at an agreeable price. This creates a floor price on the bond which appeals to investors and thus lowers the desired yield on the bond. Many convertible bonds provide both options.

The mandatory convertible bonds are issued by the companies with a particular conversion date. The bonds are required to be converted by the investors to the underlying stock no further than this date. These bonds often have relatively short tenures.

The exchangeable bonds come up with a special trait where the underlying bond and the stock are from different issuers. Exchangeable bonds do possess all the other traits of convertible bonds.

These bonds must achieve a price above the conversion price before they get converted. The required price is often some fixed percentage above the conversion price, and the stock must trade at the required price for a pre-defined price before conversions are permitted.

The denominations of these convertibles are in a currency other than the denominations used in the issuer’s country. This characteristic would make the bond preferable because interest payments would not be based on the exchange rate fluctuations that result in fewer dollars per thousand rupees.

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Features of Convertible Bonds
  • The conversion from the bond to stock can be done at certain times during the bond's life and is usually at the discretion of the bondholder.
  • A convertible bond provides the investor the option to convert the value of the outstanding bond into equity of the borrowing firm, on pre-specified terms.
  • Exercising this option leads to redemption of the bond prior to maturity, and its replacement with equity.

Frequently Asked Questions

A convertible bond is a corporate debt security and a source of a fixed income. It provides periodic returns until it is converted into equity shares.
The key convertible bond types are Vanilla convertible bonds, Mandatory convertibles, and Reverse convertibles.
Investing in convertible bonds is relatively safe. An investor gets the option to get the purchased bonds converted into equity shares.
No, private organisations cannot issue convertible bonds.
Companies issuing Convertible Bonds get the advantage of Tax benefit and low interest payments.
Individual Convertible Bonds should be bought through a professional broker or convertible bond expert at BondsIndia.
The point at which the conversion option becomes worthless and the lowest value to which a bond can drop is known as the floor value of the convertible bond.

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