YOU WILL RIDE IN
ONE OF THE SAFEST FORMS OF INVESTMENT VEHICLES
This vehicle is particularly designed for long-term investments (2 to 5 years). It is a perfect model for self-administered pension funds and fits well into any financial or investment plan.
A convertible bond is not a new product, it has been on the market for at least a century. For example, U.S. Railroads were built partly from the proceeds of convertible financing.
A convertible bond is part debt, part equity. For the investor, a convertible offers the safety of income and principal protection that bonds offer, as well as the growth potential of equity. For the issuer, a convertible offers the possibility of selling stock at a premium and the attraction of low cost debt. For both parties, a convertible is neither all debt, nor all equity. It is a true hybrid.
Volatility: Historically, convertibles are about 40% less volatile than the average common stock. Despite this reduced risk, convertibles usually provide total returns that are competitive with common stock, as demonstrated over many years.
Safety: Convertible bonds are senior securities of a company with all the characteristics of conventional bonds. It is a certificate of debt issued by a corporation to the bond holder with promises to pay interest on a regular basis and repay the principal at maturity. It may be exchanged, at the option of the holder, into a predetermined number of shares of the issuing companiesí common stock.
It is the bondís protection against loss of principal which enables convertibles to maintain consistency. Convertible bonds will not fall in value like their common stock counterpart.
As simplistic as it sounds, not losing money is a key to long-term performance, since a 50% loss in principal, requires a 100% appreciation of the remainder to recoup the loss. From this standpoint, convertible bonds provide a remarkable advantage to the investor.
Financial engineering: We can financially engineer a convertible bond portfolio, as a debt portfolio, an equity portfolio or a mixture of both.
When the portfolio is financially engineered as a debt portfolio, we should be looking for:
1) Higher safety of investment,
2) Higher interest yield,
3) Lower capital gain due to the high conversion premium.
When the portfolio in financially engineered as an equity portfolio, we should be looking for:
1) Lower safety of investment,
2) Lower interest yield,
3) Higher capital gain due to the low conversion premium.
Convertible bonds contains investment characteristics of both debt and equity securities.
Convertible bonds truly represent:
" THE BEST OF BOTH WORLDS "
INVESTING IN CONVERTIBLE BONDS
There are three (3) main reasons why an investment in convertible bonds should be made.
1) Convertible bonds offers the safety of income and
2) Convertible bonds offers the growth potential of equity.
3) Historically, convertible bonds are about 40% less volatile
A convertible bond is part debt, part equity.
For the investor, a convertible bond offers the safety of income and principal protection that debt offers, as well as the growth potential of equity.
For the issuer, a convertible bond offers the possibility of selling common shares at a premium, and the attraction of low cost debt in the period before it is converted. For both parties, a convertible bond is neither wholly debt, nor equity. It is a true hybrid.
DIFFERENCE BETWEEN CONVENTIONAL BONDS
There could be a huge difference between buying Conventional bonds and Convertible bonds.
Conventional bonds are standard bonds bearing a coupon, paying interest twice a year and have a maturity date at which they will redeem their bonds at "par", ($1000). The price of conventional bonds will change primarily with the change in interest rate.
Convertible bonds have the same characteristics as conventional bonds. They have a coupon, pay interest twice a year and at maturity they will redeem their bonds at "par", ($1000).
The bonus with convertible bonds is that they are convertible into a known number of common shares of the company. The number of shares into which it is convertible multiplied by the price of the common share is called the "conversion value". The convertible bond will always trade above its conversion value.
The upside in the price of the bond is unlimited, it is directly attached to the price of the common share through the mathematical formula: (number of shares x price of shares). Ie: If the bond is convertible into a 100 shares and the price of the share is $10, then the conversion value is (100 shares X $10) = $1000. If the price of the share rises to $15, then the conversion value of the bond is (100 shares X $15) = $1500.
The downside in the price of the bond is limited through its investment value. The investment value is drawn both from its conversion privilege ( price of the common shares) and from the value it commands as a bond.
The convertible bond price will rise with its conversion value but its price will normally fall no lower than its investment value.
WHY BUY CONVERTIBLE BONDS RATHER THAN COMMON SHARES ?
1) Convertible bonds are less risky.
2) Convertible bonds almost always provide greater income.
3) Fairly priced convertible bonds are always favorably "leveraged".
(They will rise more than they will fall on an equal move, up or down, in the price of the common share).
4) Convertible bonds have consistently outperformed common shares, when both income and price appreciation are measured, ( Total return ).