Convertible Bonds: This Is What Potential Investors Should Pay Attention To

Convertible bonds are not the same as reverse bonds, but what are their special features and how do they differ from other bonds? Are there any advantages over normal bonds?

A convertible bond is a security that pays a fixed interest rate but, unlike other bonds, can be converted into shares at the end of the term. In this case, the owner of the share bond has the right. It is up to him whether he ultimately decides to pay out in capital or to pay out in shares.

Main Characteristics Of Convertible Bonds

The most important feature is that, like other bonds, it has a fixed interest rate, but if the holder of the bond so wishes, it can be exchanged for a certain amount of shares.

The exact conditions are determined before the purchase, which means that you are not allowed to choose the number of shares or the quantity.An exchange period is also determined. This usually begins a few weeks after the issue and continues until the last days of the bond's term.

Practical Examples

These conditions could therefore mean that with a nominal value of 1000 euros, you can exchange it for 50 shares. In this case, this means that the exchange ratio would be 1:20 and therefore the owner would receive shares for every 20 euros of nominal value. Due to this exchange regulation, the owner can now calculate whether and at what rate a conversion would be more lucrative.

In expert circles, the value of the share when you convert is called the conversion price and the possible profit that you can make with a conversion is called the conversion premium. Therefore, you could get more out of the bond using this regulation. You can use a formula to calculate exactly when a conversion will pay off.

To stick with the example given above, a share must cost more than 20 euros for such a conversion to be recommended. The costs are not taken into account in this example. The payout in capital is less risky because the risk that you carry with you after the conversion can mean that if the stock collapses, you can lose all of your profits and the bond can therefore subsequently become a loss.

Conclusion

However, you must be aware that you will be a shareholder after such a conversion. This means that you have to deal with all the risks and opportunities of being a shareholder. The convertible bond does not only have advantages, because in order to get this special conversion right you have significantly lower interest rates than with the reverse convertible bond.

So everyone has to decide for themselves whether they think a convertible bond is a good investment. So this form of bond is significantly more complicated than the normal form of bonds.