You must have heard about many types of bonds and you will also know about many. But do you know what are convertible bonds? These are debt securities, which are different from traditional bonds. Investing in convertible bonds can be complicated and risky. Investors should know how they work before investing in such securities. So through this article we are going to give you information about convertible bonds.
These are a type of date security. It provides investors with the option to convert the bond into pre-specified shares during the lifetime of the bond. This change of bond can only be done with the issuing company. It is a type of hybrid security that features both equity and debt securities.
Types of convertible bonds
Convertible bonds are not classified into formal categories of the financial market, but the following terms are used when referring to the types of these bonds –
Vanilla Convertible Bond
This is the most basic type of convertible bond. In this type of bond, investors can convert their bonds into certain shares at a pre-specified conversion price during maturity. Coupon payments are offered to investors during the bond’s lifetime, which have a fixed maturity date. Upon maturity, investors become eligible to receive the face value of the bond.
In this type of bond, investors are required to convert their bonds into shares at the time of maturity. Such bonds have two conversion values.
In reverse convertible bonds, the bond issuer has the option to buy back the bonds from investors or convert the bonds into equity at a pre-specified conversion price during maturity.
How to invest in convertible bonds?
To invest in convertible bonds, the investor must have good knowledge and knowledge related to it. In addition, investors should do extensive research before investing in convertible securities, as these can be complex and risky. Investors should be aware of past performance of convertible bonds of a company and while investing, investors should have an idea of how the company may perform during the lifetime of the bond. If the company does not have a positive outlook, then you should avoid such an investment. Investments in convertible bonds are done through a broker or fund house.
Many leading fund houses offer mutual fund schemes, which invest in convertible bonds. While investing in it, it should be noted that the portfolio of convertible bonds performs similarly to high dividend equity funds. Investors can use such investments to diversify their portfolios. This type of investment is beneficial for those investors who have invested a major portion in debt securities, whereas those investors who have mainly invested in equity should make such investment with caution.
Risk associated with convertible bonds
Convertible bonds carry the risk of interest rate risk as well as default risk. As we know that bond prices fall when interest rates rise, so investors should keep in mind the interest rate while investing in such securities. In addition, there is market risk in convertible bonds due to the equity component. Experts believe that investors should consult professionals before investing in convertible securities to know about such investments. Thus you can understand that there is a risk in investing in convertible bonds. Therefore, one should be very careful while investing in it.
Benefits of convertible bonds
Convertible bonds have many benefits, some of which are –
Low interest payment
Investors are usually paid at a lower interest rate in convertible bonds than regular bonds. Investors accept such an interest rate due to the equity factor associated with it. This helps the issuing company to withdraw money from investors at a lower interest rate, leaving them some money on their interest payments.
Tax is deducted on payment of interest. The convertible bond issuer benefits the company through tax savings on interest. This facility is not possible in equity.
Convertible bonds are a convenient way to finance companies that are not ready to liquidate their equity shares in the short or medium term, but can or will do so in the long run.