Convertible bonds are corporate debt securities that generate a fixed income. These bonds are issued by corporations when there is a requirement for funding. You can convert these bonds into equities in the future and become a shareholder in the organisation.
Continue reading to learn about convertible bonds’ associated benefits and risks, when to convert these bonds, and more.
Convertible bonds work just like regular bonds, providing you with a fixed income on your principal. However, the difference here is that you can convert your debt investment into equities (shares) of the issuing company.
The conversion happens during the tenure of your bond and depends on the type of convertible bond you own. This conversion may also be compulsory if you have a mandatory convertible bond.
Once the conversion occurs, you become a shareholder and are no longer a bondholder. After conversion of bonds to equity, the returns will not be fixed and depend on the performance of the issuing company.
The number of shares you will receive depends on the conversion ratio mentioned in the bond. For example, if a conversion ratio is 15:1, you will get 15 shares against one unit of debenture. You will also mention the conversion price on the bond.
Here are the common types of convertible bonds you can invest in.
This bond needs to be converted into shares within a specific timeline. Here, the bond will have a predetermined date for conversion. In this case, you do not have the option to cash in. The number and value of shares will depend on the conversion ratio and price mentioned in the bond.
Unlike the mandatory convertible bond, you can choose whether to convert your bond to shares or not. To decide the ideal time for conversion, you will have to closely monitor the issuing company’s stock.
In this bond type, the issuer chooses when to convert the bond. The issuing company may decide to convert the bonds or offer the bondholders cash on maturity. This conversion happens based on the conversion ratio and price mentioned.
Listed below are some of the must-know features of convertible bonds.
Investors could become shareholders of the issuing company
Better returns upon conversion to equity
Conversion ratio and rate decide the number of shares and their price
Convertible bond interest rate is generally low
Comparatively low risk and volatility due to it being a debt instrument
Knowing the pros and cons of convertible bonds gives you a holistic view of it, enabling you to make an informed decision.
Here are some of its advantages and disadvantages.
Fixed income until conversion
Comparatively low interest payout
Possibility of higher returns upon conversion
Equity dilution if bondholders convert
Low risk of default
Lower liquidity than other bonds
The right time to convert your bonds into equities depends on the type of convertible bond you own. Preferably, the conversion should happen when the share value is higher than your principal investment (face value), including the interest you could earn.
You will need to monitor the issuing company’s stock movement to gauge whether there is an upward trend or not. A favourable market implies that you can get better returns right now and potentially in the future as well.
Before you invest in convertible bonds, check out the following tips:
Align your risk appetite and the investment’s risk
Look at the conversion ratio and price to gauge your investment’s future value
Evaluate the investment horizon to ensure it is in line with your goals
Ensure the conversion terms suit your investment goals
Verify the issuer’s credibility to secure your funds
Now that you know convertible bonds’ meaning and benefits, be sure to consider these factors before you invest. You should also prioritise diversification of your investments to mitigate the risks.
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Convertible bonds are hybrid debt instruments that allow you to convert your debt investment into equities of the issuing company. Prior to conversion, this bond offers fixed income on your principal investment.
A convertible bond is essentially a debt instrument. However, you can convert it into equity during the tenure at a specified time.
A distinct feature of this bond is that you can convert your debt investment into equity at a specified time during the tenure. As the company valuation goes up, your returns may increase since the investment would be in equity after conversion.
Like most bonds, a convertible bond is a low-risk instrument. However, there may be some general investment risk and conversion risk involved, wherein you may not receive the same value.