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Return To Bonds Article Archive   Convertible Corporate Bonds By Nick Hunter Convertible corporate bonds offer investors the opportunity to own a bond that is convertible into a set amount of common stock of the company. The benefits can work for the investor and the company. For the corporation, they are hoping their bond investors convert so that they do not have to pay on the bond anymore and they gain shareholders. Investors see them as protection against interest rates rising and an opportunity to buy stock in a company that they already have a relationship with. There are also spread or arbitrage opportunities between the stock and bond price, as you will see. Convertible bonds hold their price value better than non converting bonds, because the market has priced in that feature. Most bonds are not convertible, but the few that are can be very beneficial to own. You can pick and choose your timing and even have a target stock price that you will wait on before converting. One risk to the company is there is a potential dilution in the stock when bonds converted. The excess shares created will normally hurt the EPS (earnings per share). Because of this, the issuing of convertible corporate bonds by a company requires shareholder voter approval before they are issued. The mechanics and the attractiveness of converting a bond come down to a few things: Conversion Price Common Stock Value Par Value Bond Value Parity The conversion price is fixed for the life of the bond. This does not represent the price that you can own the stock at. It is not an 'option price'. It is a price that when divided into the par value of the bond (based on how many you own), will equal your shares - also known as the conversion ratio. An example would be: A customer owns ABC convertible bond that is selling in the market at $1040 or $104, the common stock is selling at $54 and the conversion price is $50. The investor would like to convert, but will only do so when the stock value is trading above the bond value. 'Parity' would occur when the bond and stock are equal. The first thing you must find out is the amount of shares the customer is entitled to. We get that by dividing the conversion price into the par value of the bond ($1000). $1000 divided by 50 equals 20. The investor can convert out of the bond into 20 shares of stock - no more, no less. The stock is currently trading at $54. The stock value is found by multiplying 20 (shares) by $54 (stock value), which equals $1080. $1080 is above the bond selling price of $1040, so converting at this time would meet the customers objectives of converting only when the stock value was above bond value or 'above parity'. Its also helpful when you own these bonds to figure out what price on the stock will the bond be at parity. Lets look at another example. A bond that you own is currently selling at $1160 or $116, and the conversion price on the bond is $50. At what price on the common stock will true parity occur? You want to convert the bond, but you only will when the stock value (based on your shares) will be equal to $1160. First, you must figure out the shares or conversion ratio. Par value of $1000 is divided by $50, which equals 20. Then, you divide the bond price of $1160 by 20. That will equal $58. Thus, if the stock in the company rises to $58, based on 20 shares - it equals $1160 or parity. Convertible corporate bonds have a place in every bond investors portfolio. As long as the rating is investment grade, the risk is minimal, and the returns on the bond or the stock can be rewarding. Learn More About the Author: Nick Hunter is the President of American Investment Training, AIT and he writes for www.brokerjobs.com - A financial career and education website.

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