Convertible Bonds - Meaning, Types & Advantages of Convertible Bonds

What are Convertible Bonds?

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

Who issues these Bonds?

Convertible BondsIndia are issued by corporations having high growth expectations and less-than-stellar credit ratings.

Types of Convertible Bonds

Vanilla Convertible
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.

Embedded Options
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.

Mandatory Convertible
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.

Exchangeable Bonds
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.

Contingent Convertibles
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.

Foreign Currency Convertible Bond
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 more preferable, because interest payments would not be based on the exchange rate fluctuations that result in fewer dollars per thousands of rupees.

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Vanilla Convertible
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.

Embedded Options
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.

Mandatory Convertible
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.

Exchangeable Bonds
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.

Contingent Convertibles
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.

Foreign Currency Convertible Bond
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 more preferable, because interest payments would not be based on the exchange rate fluctuations that result in fewer dollars per thousands of rupees.

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.

Why Invest in Convertible Bonds?

Investing in convertible bonds can be a good decision for many investors. You earn a fixed interest until maturity on your investment in convertible bonds. You also enjoy the stock value appreciation benefit.

Advantages of Investing in Convertible Bonds

Higher Yields

Convertible BondsIndia is generally considered for higher yields. The Convertible bonds yields in comparison to common stocks is high. Also, it provides a fixed income in the form of interest.

Risk Level

The level of risk involved in convertible BondsIndia is less. In case the issuing company is required to go for liquidation, the bondholders are given the first preference. This, minimizes the risk of default and guarantees your investment to a certain level.

Dual Benefits

An investor holding a convertible bond gets dual benefits. Apart from earning a fixed interest income as a bondholder he or she can get the bonds converted into equity shares if the company performs well.

Who Should Invest in Convertible Bonds?

Investing in Convertible Bonds is a good option for investors looking for fixed interest rate and the flexibility to convert the bonds into equity at the time the company starts performing well. The default risk in Convertible debt is minimal.

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Frequently Asked Questions

What are Convertible Bonds?

A convertible bond is a corporate debt security and a source for a fixed income. It provides periodic returns until it is converted into equity shares.

What are the key convertible bonds types?

The key convertible bonds types are Vanilla convertible bonds, Mandatory convertibles, and Reverse convertibles.

Why invest in convertible bonds?

Investing in convertible bonds is relatively safe. An investor gets the option to get the purchased bonds converted into equity shares.

Can private organisations issue convertible bonds?

No, private organisations cannot issue convertible bonds.

What are the major advantages of Convertible Bonds?

Companies issuing Convertible Bonds get the advantage of Tax benefit and low interest payments.

How do I buy Convertible Bonds?

Individual Convertible Bonds should be bought through a professional broker or convertible bond expert at BondsIndia.

What do you understand by the floor value of a convertible bond?

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.