WHAT IS Revertible

Revertible is a term that refers to a special type of convertible corporate bond that automatically converts itself into shares of the company's stock in the event that the underlying stock drops below a specific price. A traditional convertible bond is a corporate bond that gives the bondholder the right, but not the obligation, to convert the bond into shares of the company's stock. There is no trigger price in a traditional corporate bond, and the bondholder can decide to convert into shares of the company's stock or not. These revertible bonds usually have an expiration date or time limit at which point the bond will automatically either convert into a stock or revert to a bond forever. Revertible bonds tend to pay very high interest rates and are offered by risky companies that are not considered investment-grade.

Revertible bonds are also known as reverse convertible bonds.

BREAKING DOWN Revertible

Revertible bonds are a special type of corporate bond, in which the bond automatically converts itself into shares of the company's stock when the share price drops below a certain price. Revertible bonds can be seen as stabilizing or dangerous to your portfolio, depending on how you view them. Since the automatic conversion feature of the bond only kicks in when the stock price falls below a certain point, the conversion reflects a view from the market that the company is less stable that it has previously been. If this is the case, it may make more sense to own shares of the company than to own a bond issued by the company, because it is much easier to sell shares of stock than it is to sell an illiquid bond. However, since bondholders get priority over stockholders of common stock when a company is liquidating its assets, an investor might wish to have holdings in a failing company in a bond rather than in stock shares.

Risk of Revertible Bonds

Revertible bonds pay very high interest rates because they have to compete with the potential upside of having the investment in shares of the company's stock instead. The tradeoff of stability in a bond is the higher potential payoff of a more volatile investment format of shares of stock. This only makes sense in a company with a high risk profile that isn't considered investment grade, because there is already risk, and therefore a higher return, to owning a bond issued by this company. More stable companies would find it more challenging to offer revertible bonds, because the share price of their stock wouldn't be expected to fall, but also because there is virtually no risk to owning one of their corporate bonds, rendering it an extremely lopsided choice between bond and stock shares in terms of risk and potential reward. This lopsided choice makes revertible bonds ridiculous for large, established companies.