A:

The difference between a regular convertible bond and a reverse convertible bond is the options attached to the bond. While a convertible bond gives the bondholder the right to convert the asset to equity, a reverse convertible bond gives the issuer the right to convert to equity.

To review, convertible bonds give bondholders the right to convert their bonds into another form of debt or equity at a later date, at a predetermined price and for a set number of shares. Convertible bondholders are not obligated to convert their bonds to equity, but they may do so if they choose. The conversion feature is analogous to a call option that has been attached to the bond. If the equity or debt underlying the conversion feature increases in market price, convertible bonds tend to trade at a premium. If the underlying debt or equity decreases in price, the conversion feature will lose value. But even if the convertible option comes to be of little value, the convertible holder still holds a bond that will typically pay coupons and the face value at maturity. The yield on this type of bond is lower than a similar bond without the convertible option because this option gives the bondholder additional upside.

Reverse convertible bonds are a similar vehicle to convertible bonds as both contain embedded derivatives. In the case of reverse convertible bonds, the embedded option is a put option that is held by the bond's issuer on a company's shares. These investments give the issuer the right, but not the obligation, to convert the bond's principal into shares of equity at a set date. This option is exercised if the shares underlying the option have fallen below a set price, in which case the bondholders will receive the equity rather than the principal and any additional coupons. The yield on this type of bond is higher than a similar bond without the reverse option.

An example of a reverse convertible bond is a bond issued by a bank on the bank's own debt with a built-in put option on the shares of, say, a blue chip company. The bond may have a stated yield of 10-20%, but if the shares in the blue chip company decrease substantially in value, the bank holds the right to issue the blue chip shares to the bondholder, instead of paying cash at the bond's maturity.

To learn more about convertible bonds, see Convertible Bonds: An Introduction.

RELATED FAQS
  1. Where does the stock come from when convertible bonds are converted to stock?

    First, let's define convertible bonds. A unique combination of debt and equity, they provide investors with the chance to ... Read Answer >>
  2. How do I use a premium put convertible?

    Holders of convertible bonds face all the pitfalls that traditional bondholders face - liquidity risk, interest rate risk ... Read Answer >>
  3. Why would a corporation issue convertible bonds?

    Discover how corporations issue convertible bonds to take advantage of much lower interest rates as a result of a conversion ... Read Answer >>
  4. What are 'death spiral' convertible bonds?

    Conventional convertible bonds give the bondholder the right to exchange the bond for a certain amount of the issuer's common ... Read Answer >>
  5. Do convertible bonds have voting rights?

    Convertible bonds usually have no voting rights until they are converted. Even after conversion, they may not be granted ... Read Answer >>
  6. How is convertible bond valuation different than traditional bond valuation?

    Read about bond valuation, particularly the differences between how a traditional bond is valued and how a convertible bond ... Read Answer >>
Related Articles
  1. Financial Advisor

    Is Now the Time for Convertible Bonds?

    Convertible bonds offer a competitive rate of return in what is a very tough market right now. Here's how they work.
  2. Investing

    Convertible Bonds: An Introduction

    Find out about the nuts and bolts, pros and cons of investing in bonds.
  3. Investing

    Why Include Convertible Securities in Your Portfolio

    What are convertible securities and why you should include them in your portfolio.
  4. Investing

    Convertible Bonds: Pros And Cons For Companies And Investors

    Find out why businesses choose this type of financing and what effect this has on investors.
  5. Investing

    3 Best High-Yielding Convertible Bond Mutual Funds (LACFX, FACVX)

    LACFX,FACVX,VCVSX: Learn about three of the highest-yielding options available.
  6. Investing

    The Top 3 Convertible Bond ETFs for 2016 (CWB, ICVT)

    Obtain detailed information on the exchange-traded funds (ETFs) available for traders seeking ETF exposure to convertible bond investments.
  7. Investing

    Can a Bond ETF Work in a Rising Rate Environment?

    The CWB Convertible Securities ETF could be the perfect solution for a rising rate environment.
  8. Managing Wealth

    The Mandatory Convertible: A "Must Have" For Your Portfolio?

    Mandatory convertibles are a little understood security with some distinct advantages. Find out if they are right for you.
  9. Investing

    Guide To Embedded Options In Bonds

    Investors should be aware of embedded options that may be available in certain securities as these options may affect the value of the security.
RELATED TERMS
  1. Convertibles

    Securities, usually bonds or preferred shares, that can be converted ...
  2. Deferred Equity

    A type of security, such as preferred shares or convertible bonds, ...
  3. Reverse Convertible Bond - RCB

    A bond that can be converted to cash, debt or equity at the discretion ...
  4. Contingent Convertibles - CoCos

    A security similar to a traditional convertible bond in that ...
  5. Convertible Bond Arbitrage

    An arbitrage strategy that aims to capitalize on mispricing between ...
  6. Death Spiral

    A type of loan investors give to a company in exchange for convertible ...
Hot Definitions
  1. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  2. Pro Forma

    A Latin term meaning "for the sake of form". In the investing world, it describes a method of calculating financial results ...
  3. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
  4. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  5. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index ...
  6. Run Rate

    1. How the financial performance of a company would look if you were to extrapolate current results out over a certain period ...
Trading Center