Question

The Value of Convertible Bonds to Equity and Fixed Income Investors

Convertible bonds can be viewed as hybrid securities that offer investors some of the benefits of fixed income as well as equity holdings. Equally importantly though, convertible bonds include many optionalities that enhance their value substantially beyond either regular bonds or equities, to both holders and issuers. Some of these optionalities include the option to the issuer to call the bond, as well as the option to the holder to “put the bond back,” i.e., to return it to the company that issued it.

In this week’s Discussion, you will evaluate the multiple characteristics of convertible bonds that benefit issuers, as well as their holders.

To Prepare:

Review this week’s Learning Resources, as well as other resources you may access from the Internet. Consider the following:

Given that a convertible bond is callable by the issuer, its convertibility benefits to the holder may be lost. How is a convertible bond holder protected against or compensated for such a possibility? Likewise, given that convertible bonds are puttable by the holder, its cost to the issuer may be unjustified. Is there a way a convertible bond issuer could be compensated for the puttability of the bond?

Post by Day 3 a 3- to 6-paragraph assessment of the value of convertibles to various types of investors and issuers. Make sure to include responses to the following specific questions:

#1 What possible motives can an issuer have to offer a convertible bond rather than a regular bond?

#2 What kinds of optionalities do convertibles offer, in addition to their puttability, to investors?

#3 Under what circumstances would the optionalities embedded in convertible bonds be more valuable to equity investors than to fixed income investors?

Clearly address each of the questions with 1–2 paragraphs. Make sure you use APA style for your response(s) and properly cite any resources you have used.

Answer 1

1) A corporation issues a convertible bond to take advantage of reduced interest rates, since the presence of the conversion option provides upside potential for the bondholders, and these bonds tend to demand lower interest rates compared to standard nominal bonds. Another advantage of issuing convertible bonds rather than equity is the tax deduction of interest, which lowers the cost of capital for a company.

2) A puttable bond allows the investor to sell the bond back to the issuer, prior to maturity, at a price that is specified at the time that the bond is issued.the holder of a puttable bond is essentially long the bond and long the embedded put option. This has the effect of increasing the convexity of the price-yield relationship associated with this security and thus reduces the downside risk to the investor. This has the effect of increasing the price of the security and hence reducing the potential return to the investor.

3) ###

source- Investopedia