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D I F F E R E N C E    B E T W E E N

C O N V E N T I O N A L    B O N D S

AND

C O N V E R T I B L E    B O N D S

 

 

There is usually a huge difference in the "returns", 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" ($ 1,000). 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" ($ 1,000).

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, the conversion value is (100 shares X $10) = $1000. If the price of the shares rises to $15, the conversion value of the bond is (100 shares X $15) = $1,500.

The downside in the price of the bond is limited   through its investment value. The investment value of a Convertible bond, is the price at which it would trade if it were not convertible.

The Convertible bond price will rise with its conversion value but its price will normally fall no lower than its investment value.

 

EXAMPLE:

Let us compare the purchase of two bonds from the same company.

One  Conventional bond at $1000, with a coupon of 10% and

One  Convertible bond at $1,000, with a coupon of 10% and a conversion ratio of 100 common shares. The price of the common share is trading at $10.

 

                                                           CONVENTIONAL         CONVERTIBLE
                                                                    BOND                              BOND

                                                            ---------------------------           ------------------------

BUY ONE BOND:                                    $1000                                  $1000

INTEREST:                                                    10 %                                   10 %

CONVERSION RATIO:                                 0                                     100 SHARES

PRICE OF COMMON SHARE:                                                              $10

.............................................................................................

After a year:

There were no changes in the interest rate.

The price of the common share has risen from $10 to $15.

............................................................................................

 

PRICE OF BOND:                                      $1000                                    $1500 ***

INTEREST:                                                   $100                                       $100

                                                                  ---------------                             ----------------

 

TOTAL RETURNS ($):                              $100                                         $600

TOTAL RETURNS (%):                               10%                                         60%

                                                             ===========                       ===========

 

*** ( CONVERSION RATIO     X     PRICE OF COMMON SHARE )

                      (    100                     X                         $15     )                          = $1,500

 

 

RESULTS:

 

This example demonstrate easily, the "huge" difference between buying Conventional bonds and Convertible bonds.

For the same amount invested " in the same company ", the

Conventional bond yielded a 10 % return while the

Convertible bond yielded a 60 % return.

 

 

 

 

(DIFF-BON,14-01-00)