Options Of Convertible Bond

 

In financial terms, a convertible bond, also called convertible note or convertible bond, is a kind of bond that the holder may convert into an agreed amount of shares of stock in the issuer or funds of equal values. It's a hybrid financial product with equity and debt-like characteristics. A bond is usually bought from a company which has growing assets and funds in its treasury. This is done so as to meet with the needs of the financial issuer by borrowing money at a lower rate of interest, by buying back its own shares from the issuer or by selling its bonds. The conversion of the bond may take place during the maturity period or as part of the distribution of dividends.

Under the traditional concept of these instruments, bondholders are lenders. But convertible bondholders are not only lenders. Bondholders do not have to pledge their assets as collateral, unlike homeowners or home owners. Instead, they have an option to convert the bond into cash. So when the value of the bond drops, the holder does not have to find new financial means to settle the debt. He just sells the bond and becomes its owner.

There are different types of convertible bond. An interest only bond is the most common form. This is one in which the holder earns interest only upon conversion. Normally, the amount of interest per year is set by the issuer and this rate is never increased. However, if the market value of the underlying property rises suddenly, the rate may rise, thereby reducing the bond's return to the issuer.

Another kind of convertible bond is the right-to-use bond. In this case, the bondholder is allowed to use the money outstanding on the bond for any purpose. This is not the same as the right-to-call bond, wherein he can call his money back but will not be entitled to use it as collateral. In this case, the bondholder can sell the bond to another person. Note that the proceeds from a right-to-call bond are exempt from federal income taxes.

A second kind of bond is the right-to-call bond. This one allows the holder to call his money back at any point of time but is still subject to paying tax on his income. Note that this type of bond has a negative yield. This implies that if the value of the underlying property drops, so too will the amount of tax required by the issuer.

The final option is called a right-to-sell option. If the value of the underlying property does not increase for a certain period of time, then the holder has the option of selling the bond. In this case, he is required to pay the amount equal to the discounted value of the bond plus his cost. Note that under this option, he is not required to pay tax on his gains.

One more type is the option bond. This is the most commonly used option and is usually implemented in restructuring debt obligations and in cases of bank failures. When an investor opts to sell this bond, the proceeds are transferred to him without any obligation on the part of the issuer. Note that in this type, the issuer retains the full right to market the bond underlying. He can also exercise the option to sell the bond and receive the proceeds.

It should be noted that when converting bond into other financial products such as stocks, the conversion prices are affected by the economy. Usually, the better-performing stock picks do not move much in the past few months and tend to stay put. That is why convertible bond issues tend to move a little higher during the trading day but then settle down to a more reasonable level.