Convertible bonds are bonds that can be converted at a future date into either a specified number of shares of the issuing company’s stock or cash of equal value. Convertible bonds are considered a hybrid security with equity and debt features. These securities are popular for a number of reasons. The main benefits of a convertible bond are that it has no pre-determined maturity date and offers investors a variety of investment options.
Interest rate sensitive
If you’re looking for a fixed-income investment with low volatility, consider buying convertible bonds. These bonds typically have a volatility sensitivity of between 35 and 45 percent, which makes them a smart choice for investors who want the security of a fixed-income investment without the risks of equity market volatility. Although the volatility of equity markets has declined significantly since late 2015, it has recently been back on the rise, thanks to market corrections in 2018. Volatility is typically created by overreacting investors when companies don’t meet earnings estimates.
Convertibles have historically performed better than traditional fixed-income assets, particularly during periods of rising interest rates. Their ability to dampen equity market volatility makes them a desirable long-term asset allocation. Convertibles also have lower volatility than equities, which makes them a good choice for those who want a low-risk, high-return investment.
Stock price sensitive
Stock price sensitive convertible bonds are securities whose market value is sensitive to changes in the share price. In other words, when the price of the underlying stock increases, so will the convertible‘s market value. This situation can create a profitable arbitrage opportunity for the investor. To make the most of this opportunity, investors purchase a convertible security and sell an equal amount of underlying common stock at a price that’s lower than the conversion value. If this strategy works, the investor will make a risk-free profit.
Investing in convertible securities requires active management. The key to success is identifying balanced convertibles with a mix of credit and equity sensitivities. For example, a convertible with the highest credit sensitivity is likely to be vulnerable to stock market declines, but may have little upside potential. An active management team should aim to create a stable trade-off between risk and reward.
A callable bond is a type of bond that can be canceled by the issuing entity before its stated maturity date. An example of a callable bond would be a $100 bond with a 10-percent coupon. If the issuer fails to make payments on this bond, bondholders can sue to recover their investment.
Bonds are typically less risky than stocks, but inflation, taxes, and regulatory changes can all deplete the return on a bond. A callable bond’s higher interest rate helps compensate for the extra risk. Investors should consider this before investing in a callable bond. In addition, consider whether you need constant income or prefer a steady stream of returns.
Callable bonds are bonds that can be called by the issuer at any time for a certain price. This price is usually higher than the face value of the bond. The call price is usually higher in the first year after the bond has been issued and decreases with time. Callable bonds are often issued by bond issuers to take advantage of potential decreases in interest rates in the future. The issuer must compensate the bond buyer with a higher coupon rate than a noncallable bond.
When it comes to fixed income investments, convertibles can be a great choice. They have historically performed better than bonds and equities. In fact, they have outperformed both in bull and bear markets. These advantages are illustrated in Figure 5.4. In the past 10 years, convertibles have surpassed bonds and equities in performance and volatility.
Convertible bonds usually have a maturity period of about five years. In the past, these bonds typically had a much longer maturity, but shorter maturities are becoming more common today. This allows issuers to offer lower coupons. In addition, the terms of conversion can vary from issue to issue.