- Analysis and valuation of convertible bonds could fill volumes and actually do [Much has been written about convertible securities. Two volumes, in particular, explore both the basics and the arcana of these instruments. They come from the portfolio managers at Calamos Investments, an investment management firm with a focus on convertible bonds. Calamos, John P. CONVERTIBLE SECURITIES The Latest Instruments, Portfolio Strategies, and Valuation Analysis Revised Edition McGraw-Hill ,1998 and Calamos, Nick P. Convertible Arbitrage: Insights and Techniques for Successful Hedging John Wiley & Sons, Inc. 2003]. For the purpose of the Certified Financial Planner ™ examination, a working knowledge of the basic traits, the mathematics of conversion and their suitability in a client portfolio is sufficient. Evaluation considers several factors, to wit:
- Price appreciation required of the underlying common stock of the issuer for conversion to be attractive. The conversion premium ration measures this.
- The growth prospects of the underlying common stock.
- The bond's downside potential should the underlying common stock's price be so low as to render the conversion privilege worthless.
- The yield sacrifice required to purchase the convertible.
- The income advantage to acquiring the convertible bond rather than the quantity of shares of the underlying common stock that would be obtained upon conversion.
- The quality of the bond and the underlying stock, both of which are, in turn, a function of the quality of the issuer.
- The breakeven time which is the number of years over which the premium paid to acquire the convertible will be recovered through what the bondholder expects to be the favorable income differential offered by the convertible bond relative to the underlying common stock.
- Formulae: better than committing them to memory alone is an understanding of how and where they figure in the analytical and valuation process. Therefore, a detailed example is provided to bring these concepts together and reinforce them.
Information on the Globotron Meganet (GMN) 5 ¾ % Convertible Bond Due in 9+ Years and Common Stock
|Coupon rate||5 ¾ %|
|Current market price||$106.5|
|Conversion Ratio||25.320 shares of ADC/$1,000 par value|
|Non-callable for||three years|
|Maturity Date||9+ Years|
|Call Price Schedule|
|In Year 4||103.59|
|In Year 5||102.88|
|In Year 6||102.16|
|In Year 7||101.44|
|In Year 8||100.72|
|In Year 9||100.00|
|In Year 10||100.00|
|ADC Common Stock|
|Current dividend yield||2.727%|
|Dividend Per Share||$0.90|
Conversion Ratio: the number of shares of common stock that the investor receives from exercising the call option. The ratio may be valid for all or a portion of the bond's life and the ratio itself may change. It is adjusted proportionately for stock splits and stock dividends. ADC Conversion ratio: 25.32 shares
(Stated) Conversion Price: par value/conversion ratio. ADC's conversion price: $1,000/25.32 shares = $39.49
Conversion (parity) Value: conversion value = market price of common stock x conversion ratio. This formula determines the value of the security if immediately converted.
Callable and Foreign Bonds and Promissory Notes
InvestingFind out about the nuts and bolts, pros and cons of investing in bonds.
InvestingEver wondered what exactly a convertible bond does? Read the features of a convertible bond and learn how important the conversion factor is to you as an investor.
InvestingWhat are convertible securities and why you should include them in your portfolio.
Financial AdvisorConvertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).
Financial AdvisorConvertible bonds offer a competitive rate of return in what is a very tough market right now. Here's how they work.
InvestingDiscover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
InvestingFind out why businesses choose this type of financing and what effect this has on investors.
InvestingThese securities offer an answer for investors who want the profit potential of stocks but not the risk.
InvestingFind out how you can maintain your income stream by using this type of bond strategy.
Managing WealthMandatory convertibles are a little understood security with some distinct advantages. Find out if they are right for you.