What is a Premium Put Convertible
Premium put convertibles are debt securities which allows the bondholder to redeem the bond at a premium before its maturity date. This redemption may happen if its market price equals, or surpasses, an agreed-upon strike price. The bond is also convertible to stock at a conversion rate outlined in the prospectus.
BREAKING DOWN Premium Put Convertible
Pros and Cons of Premium Put Convertibles
- A put option gives the owner the right, not the obligation, to sell a security at a specified price within a specified time. Like a put option contract on a stock, this feature includes a strike price. The strike price is a value at which a specific derivative contract can be exercised. When the security reaches the strike, the investor may redeem the bond before the maturity.
- The convertibility trait allows the bondholder to convert the bond into an agreed-upon number of shares of the underlying stock. The ratio at which the bond exchanges for shares is the conversion ratio. The conversion ratio is determined at the time of issue and has an impact on the relative price of the security. The conversion involves no exchange of cash or funds, only shares of the underlying asset. If the structure of the bond is an American-style exercise, the bondholder may convert at any time. European-style exercise allows the conversion only upon maturity.
Example of Premium Put Convertible Bonds
An investor who owns an American-style premium put convertible bond with a face value of $1,000, a coupon rate of 4%, and a put feature at a strike price of $1,200. The bond's conversion is to the underlying sock of XYZ company at a ratio of 10:1.
With one year left before maturity, the bond reaches its strike price of $1200. The investor may exercise the put option, and sell the bond back to the issuer at $1,200. They will receive a premium to the $1000 par value plus the remaining year of interest. Alternately, the bondholder may convert the bond to 100 shares of XYZ stock. If the XYZ share price goes above $120 per share, this would be an attractive option.