Question

It has been empirically observed that CoCo bonds with identical maturity have a higher yield than straight debenture bonds of the same company. Why is this so?

Answer 1

A convertible bond or convertible note or convertible debt (or a convertible debenture if it has a maturity of greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features.

Convertible bonds are most often issued by companies with a low credit rating and high growth potential. Convertible bonds are also considered debt security because the companies agree to give fixed or floating interest rate as they do in common bonds for the funds of investor. To compensate for having additional value through the option to convert the bond to stock, a convertible bond typically has a coupon rate lower than that of similar, non-convertible debt. The investor receives the potential upside of conversion into equity while protecting downside with cash flow from the coupon payments and the return of principal upon maturity. These properties lead naturally to the idea of convertible arbitrage, where a long position in the convertible bond is balanced by a short position in the underlying equity.

While Straight Debenture bonds is a type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond to secure capital. Like other types of bonds, debentures are documented in an indenture.

Bond which will pay back the principal on its maturity date, will pay a specified amount of interest on specific dates, and does not carry a conversion privilege or other special features.

The key benefit of raising money by selling convertible bonds is a reduced cash interest payment. The advantage for companies of issuing convertible bonds is that, if the bonds are converted to stocks, companies' debt vanishes. However, in exchange for the benefit of reduced interest payments, the value of shareholder's equity is reduced due to the stock dilution expected when bondholders convert their bonds into new shares.

The main concept between The covertibale bond and Straight debenture bond of the same company is that Convertible bond has an option in future that they want to reddemed or they want to convert their bond in equity share of the company of which equity share are the owner of the company and voting power in any meeting of the comapny wile debenture holder have not any power related to this.

Convertible bond can be converted after some period which are deciding at the time of issuing Debt into equity share and equity share are the owner of the company and take higher return then straight debenture bond. Straight debenture bond have not any power in attending the general meeting and have not any voting right and have not an option in cnverting in equity share and only recieve interest on holding Bond. So, Convertibel bond have a higher yield or return than straight debenture bonds of the same company.