You can enjoy a good rate of interest while being able to take advantage of the stock market. There are some corporate bonds which may be converted into common stock shares of the corporation. These are called convertible bonds.
Convertible bonds usually pay a rate of interest which is somewhat lower than a straight corporate bond. However, their interest rate is normally higher than the underlying common stock dividend yield. You can have the advantage of a decent rate of interest while waiting to convert your bond into common stocks.
Unlike a bank certificate of deposit, a convertible bond’s price may fluctuate. There are two main factors causing this. First, if market interest rates rise, the price of the convertible bond inversely falls. Also, if market interest rates fall, the bond price rises.
Second, if the convertible bond’s common stock rises (falls), the price of the bond falls (rises.) These are the risks of owning convertible bonds. There are other things to watch for.
Sometimes the bond’s conversion privilege expires before the issue matures. Suppose the bond matures in 20 years. The conversion privilege may expire in ten years. Check the bond’s conversion privilege details before buying.
Convertible bonds may be subject to a call. This usually happens when the convertible is selling above its investment value. That is, if interest rates drop and the issue gains in value, the bond may be redeemed before it matures.
Also, if the issuing corporation is bought out by another company, the convertible bonds may be hit hard. During buyouts, the seller’s common stock may rise. If it does, the convertible goes up and trades at a premium. However, the buyer may pay bondholders a lower price than the current market price.
What is the upside of a convertible bond? Practically limitless! For example, say XYZ Corporation issues a convertible bond which may be converted into 40 shares of its common stock. The convertible was originally priced at $1000 per bond and pays 5% interest.
If the stock rises to $25 a share, the bond may be converted at no price loss. Obviously, you wouldn’t convert the bond if the stock was at $15. However, if the stock goes to $35, the bond may be converted and a gain of $10 per share is realized. Or the bond price increases, you sell it and realize a nice gain.
Convertible bonds are not without their risks. But they are a nice way to receive interest that is higher than its stock dividend yield. And if the stock price rises, you’ve made money.
Other Articles
Understanding Convertible Bonds
Convertible bonds are a great way to receive a good rate of interest with the possibility of growth. Find out more about these hybred investments.
Understanding the Fundamentals of Common Stocks
Getting started in buying common stocks for growth can be a scary thought in today´s wacky markets. However, knowing the basics of stocks can be a real boost for the conservative investor.