Convertible Securities

Convertible Securities

Convertible securities are a kind of hybrid financial security that has developed over time and offers special advantages to both investors and issuers. Convertible securities are defined further down. 

The term “convertible” is most commonly used to describe sedans that have the option to convert into open-top cars in the automotive industry. Similarly, “convertible” denotes a special category of financial assets that have the potential to transform into a company’s stock. The idea is simple to understand once you hear it explained, even though it sounds complicated right now. What follows is a discussion of the characteristics and kinds of convertible securities. 

What are Convertible Securities? 

The ability to alter an investment’s original form into another one makes it a convertible security. Convertible bonds and preferred shares are the most prevalent forms of convertible securities. The former may be changed into common stock, and the latter can be turned into bonds. 

Bonds with convertible coupons and preferred shares with convertible dividends are examples of convertible securities that pay a fixed amount at regular intervals and specify the conditions and price at which they can be converted. 

Understanding Convertible Securities 

If you’re looking for a way to invest in bonds with more appreciation potential and a better income potential than common stocks, convertibles are a terrific option. For example, compared to regular bonds, convertible bonds usually have a lower coupon. The bond’s value, however, is enhanced because of the opportunity to convert it to common stock. 

Debt, equity, and hybrids of the two are the three most common forms of investment. Because of their combined bond-like and stock-like cash-flow characteristics, convertible instruments are considered hybrids. 

Convertible bonds are a type of debt, just like any other bond. Companies often provide investors with a fixed rate of interest, called the coupon rate, in return for their capital. Unlike a regular bond, the holder of a convertible bond has the option to exchange it for stock. 

Convertibles are popular among investors because of the loss protection they provide, although they do sacrifice some value during appreciation. Callable convertible bonds allow the issuing business to coerce the bondholders into making the conversion. Here, convertibles’ upside potential is restricted. 

Working on Convertible Securities 

The payment on convertible securities is often smaller than on similar securities without the conversion mechanism. Because the conversion feature allows investors to profit from it, investors are often ready to accept a reduced dividend in exchange for a share of a company’s common stock. 

The conversion value and the common stock call option value resemble each other in striking detail. It is normal practice to set the conversion price, the predetermined price at which the security can be converted into common stock, higher than the stock’s current price. Call values are higher when conversion prices are closer to market prices. The par value and coupon rate determine the underlying security’s value. The two figures are combined to provide a fuller view of the security’s worth. 

Convertible securities are very sensitive to changes in the value of the underlying common stock. The degree of connection grows as the stock price gets closer to or beyond the conversion price. If the stock price is well below the conversion price, the asset is more likely to trade as a straight bond or preferred share because the chances of conversion are seen as unlikely. 

Types of Convertible Securities 

Two of the most prevalent forms of convertible securities are preference shares and bonds. Let’s examine them more closely. 

Convertible bonds 

Debt instruments known as “convertible bonds” allow bondholders to swap their bond for a certain number of shares in the issuing firm at a future date. It combines elements of debt and equity, making it a hybrid security. 

A convertible bond is structured similarly to a standard bond, paying interest and having a maturity date. If you opt not to convert the bond to equity, the face value will be paid to you upon maturity. The bond will only have equity characteristics if you convert it to the company’s shares; it will no longer have any debt qualities. 

If a corporation were to issue convertible bonds, why, though? Investors are enticed to convert to equity, which allows them to provide a lower coupon rate. Another crucial factor is that the corporation waits to dilute its shares after purchasing the firm before converting it to stock. So, instead of paying back the bond’s face value when it matures, the corporation may save money by turning it into equity shares. 

Convertible preference shares  

Let’s explain preference shares before we discuss convertible preference shares. As the name implies, preference shareholders receive dividends before regular stockholders. Preference shareholders do not often have voting rights, and the dividend rate on most preference shares is set. 

The ability to change convertible preference shares into common shares is a feature of these shares. Before conversion, the dividends on convertible preference shares remain constant. When converted to common stock, they become fully voting shareholders and are eligible to receive dividends declared by the firm. 

Examples of Convertible Securities 

An organisation is looking to acquire more cash through a 10-year bond issue; its common stock is currently trading at $5 per share. A rate of eight per cent is in place, determined by the company’s creditworthiness. With the addition of a conversion option at $10/share, the corporation decides the interest rate may be lowered to 6%. Using a $1,000,000 convertible bond issuance results in a $20,000 annual interest savings for the corporation. 

In contrast to a nonconvertible bond, which would pay $800,000 in interest over 10 years, a convertible bond would pay $600,000 ($60,000 annually times 10 years). The investor stands to collect an extra $200,000 in capital gains if the stock price increases to $12, though, because they may exchange their bond for $10 worth of common shares. If the stock price goes up by more than $12, more money will come in. If the bond’s value rises throughout the bond’s 10-year term, the investor can cash out at any point. 

In summary 

To sum up, convertible securities are assets that may be changed into stock at a later date. On the whole, these securities are good for whoever issues them and for investors. But before putting money into these securities, investors should read the issue’s terms and conditions carefully. 

Frequently Asked Questions

If the value of the underlying stock goes up, the investor might end up with more money in their convertible securities. Bonds, notes, and convertible preferred stock are all forms of convertible securities that can provide income in the form of interest payments or dividends. 

Forced conversion happens when the stock price is greater than what would be required to redeem the bond, and diluting control of the firm is another danger associated with convertible instruments. 

The conversion ratio, which is decided when the security is issued, affects the relative value of a convertible security. The ratio is the par value of the convertible security divided by the equity conversion price. 

An investor can get 100 shares when they convert the bond into stock; those shares might be sold for a total of $1,100. The goal of convertible bond arbitrage is to profit from the mismatch in price between the underlying stock and the convertible bond. 

Those who can patiently wait for the maturity time to end usually do well with these investments. Companies with great growth potential but little money often provide these, which makes them appealing to investors. 

    Read the Latest Market Journal

    Weekly Updates 27/5/24 – 31/5/24

    Published on May 27, 2024 63 

    This weekly update is designed to help you stay informed and relate economic and company...

    Unlocking Stock Market Potential with AI

    Published on May 24, 2024 95 

    Introduction of AI In the world we live in today, artificial intelligence (AI) is almost...

    Financial Sectors Thriving: Top Traded Counters in April 2024

    Published on May 21, 2024 157 

    At a glance: The Federal Reserve (Fed) held interest rates steady at 5.25% to 5.5%...

    One Dollar at a Time: The Potential of Fractional Shares

    Published on May 20, 2024 97 

    Table of contents 1. Introduction 2. Dollar-Cost Averaging 3. Popularity of Dollar-Cost Averaging 4. Small...

    Unit Trusts vs Exchange Traded Funds (ETFs) – Which is better for your portfolio?

    Published on May 20, 2024 106 

    Imagine you are dining at a nice restaurant, feeling overwhelmed by the variety of seemingly...

    Weekly Updates 20/5/24 – 24/5/24

    Published on May 20, 2024 23 

    This weekly update is designed to help you stay informed and relate economic and company...

    What is CFD? With 2 Practical Examples

    Published on May 15, 2024 114 

    In this article, you will learn what CFD (Contract for Difference) is, the costs and...

    What is ESG investing, and why is it important?

    Published on May 15, 2024 126 

    Over the last five years, Environmental, Social, and Governance (ESG) investing has evolved from being...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com