Convertible Bond - Uses For Investors

Uses For Investors

• Convertible bonds are usually issued offering a higher yield than obtainable on the shares into which the bonds convert.

• Convertible bonds are safer than preferred or common shares for the investor. They provide asset protection, because the value of the convertible bond will only fall to the value of the bond floor. At the same time, convertible bonds can provide the possibility of high equity-like returns.

• Also, convertible bonds are usually less volatile than regular shares. Indeed, a convertible bond behaves like a call option. Therefore, if C is the call price and S the regular share then

In consequence, since we get, which implies that the variation of C is less than the variation of S, which can be interpreted as less volatility.

• The simultaneous purchase of convertible bonds and the short sale of the same issuer's common stock is a hedge fund strategy known as convertible arbitrage. The motivation for such a strategy is that the equity option embedded in a convertible bond is a source of cheap volatility, which can be exploited by convertible arbitrageurs.

• In limited circumstances, certain convertible bonds can be sold short, thus depressing the market value for a stock, and allowing the debt-holder to claim more stock with which to sell short. This is known as death spiral financing.