What are convertible bonds? What are the advantages and disadvantages of convertible bonds?

In the securities and business environment, there are not only bonds and stocks but also convertible bonds that make investors more headache when deciding on investment forms.

So what is a convertible bond? What are the advantages and disadvantages? Let’s find out with Fastloans.PH through the content of this article!

What is convertible bonds?

 In essence, convertible bonds are considered as a product between corporate bonds and the right to buy shares issued by enterprises.

In which the right to buy shares gives the holder of the stock the right without obligation to buy the stock at a future time at a predetermined price.

convertible-bonds

What are international convertible bonds?

 An international convertible bond is simply a type of convertible bond originating in other countries, a bond that converts into shares for a certain period of time in favor of investors.

Investors will get a lot of benefits from this. Because of this, convertible bonds always attract many investors.

Examples of convertible bonds

 To clarify what a convertible bond is, please pay attention to the following example:

Company A has 1 million shares at the market price of 1000 PHP/share. After that, the company issued another one hundred thousand convertible bonds with par value of 10 thousand PHP/bond with interest rate of 5%/year.

After 1 year from the issuance date, it can be converted into company A shares for 5 thousand PHP/share at the rate of 10:1 (1 bond can be exchanged for 10 shares).

Thus, investors can earn 5 hundred million Peso from bond interest. But if then the company thrives and the stock price on the market rises to 12 thousand Peso /share and the investor converts to shares. At that time, the profit from shares compared to the market was 7,000 PHP/share (equivalent to 700 million PHP).

See also: What is Recession? The cause of the economic recession

Features of convertible bonds

 Convertible bonds have the following characteristics that customers should note as follows:

– Conversion rate: This ratio represents the number of shares received when it is converted from 1 bond. This ratio is fixed by the company right after the bond is issued.

– Conversion period: This term is varied by bond issuers, depending on the company’s decision. There are types that can be converted at any time and there are types that can only be converted at a certain time.

– Interest rate of bonds: Like regular bonds, convertible bonds also bring periodic interest to investors. However, this return will be lower than the original stock.

– Forced conversion: This is the case when the share price is higher than the value that would have been reached by the time the bond was called or redeemed. This feature will reduce the potential for overpriced convertible bonds.

convertible-vs-straight-bonds

Advantages and disadvantages of convertible bonds

Advantages of convertible bonds

 For issuers: There is more ability to raise capital in the market when the issuance of bonds and shares is not favorable.

The interest rate of convertible bonds is lower than that of conventional bonds, allowing the company to raise capital at a low cost. When bondholders make the conversion, it will favorably affect the company’s capital.

For investors buying bonds: Guaranteed to enjoy a fixed interest rate when the conversion has not been carried out and not bear any risk from the company. Create opportunities for investors to benefit when the company’s stock price increases.

Disadvantages of convertible bonds

 For the issuing company: Make the company fall into a passive position in capital organization. If the company earns a high profit then investors will switch to the stock and add new shareholders causing turmoil in the company. Make the company’s taxable income increase and after-tax income decrease.

For investors: When they have not converted or have no opportunity to convert to stocks, they will only enjoy lower interest rates than ordinary bonds.

Value of convertible bonds

 Basically, a convertible bond is considered a mixed product because it is both a corporate bond and a type of stock issued by a business.

The value of convertible bonds can be calculated using the following formula:

   Convertible Bond Value = Bond Value + Conversion Right Value

Where the value of the bond is the present value of the principal and interest of the bond in the future. The conversion value is determined according to the price of the company’s shares on the market, when the price increases, the conversion right increases and vice versa.

The longer the exercise term of the conversion right, the greater the value of the bond, thereby benefiting the convertor.

Conclusion

 The above content has answered the question of what is a convertible bond and what are the characteristics of this type of stock. Hopefully, the above article will help those who are intending to invest in convertible bonds to have the most overview and make an informed choice.

See also: What is balance sheet? Definition, example, explanation

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