As with every type of financial investment there are advantages and disadvantages to convertible bonds. This type of investment can be considered a hybrid financial product. A convertible bond allows an investor to convert the bond to common stock in an individual corporation. This type of bond is great for emerging growth firms in that it allows them access to funds inexpensively.
There are pros and cons for this investment instrument for individual investors.
PROS of Convertible Bonds
Convertible bonds offer an investor the opportunity for income in a company in that they typically pay a fixed rate of interest. They also allow an investor the ability to take ownership in the company when they convert that bond to a stock.
An investor that is satisfied with that fixed rate of interest can rest a little easier and not have to worry about the common stock fluctuating with the stock markets gyrations.
Like other types of bonds investors can park their money in them for a set number of years.
Should the company experience significant profits and a rise in it’s common shares of stock, an investor can convert the bond to the common stock. The investor can then participate in the company’s growth and profitability through the ownership of the common shares.
Should a company do badly, bondholders would normally get paid first in the event of a bankruptcy.
CONS of Convertible Bonds
An individual investor will not have voting rights as they would if they hold a common share of stock. The bond also trades at a higher value than the common stock an investor is able to exchange for it.
Usually a convertible bond has a “call provision”. This allows a company to call the bonds in for redemption. A bondholder would then have to turn in the bond for a specific value, which the company would in turn pay to the investor. An investor then would not be able to count on the fixed rate of interest for the full term of the bond.
The cost of the convertible bond is usually higher than a share of the offering company’s common stock. An investor could just purchase the common instead.
This type of investment is for experienced investors and the company issuing them should be researched carefully. The bond is usually priced out of reach for a beginning or periodic investor, typically $1000 (USD) per bond.
Convertible bonds are one of many investment instruments that should be considered carefully, even by experienced investors, before adding to your portfolio. In today’s volatile market, investors should put together a complete and diverse portfolio in order to preserve capital with the hopes of growing it. Convertible bonds could be just one component of a diversified portfolio.