On the stock exchange there are not only stocks and bonds, but also bonds that you can exchange for stocks. We’ll explain how these convertibles work and whether they’re worth it.
You can invest your money in many different ways: Quite simply, month after month in a fund, more risky in individual stocks – or you can resort to more complex products that are first bonds and can later become stocks. This special form of investment is called a convertible bond.
But what is the advantage of this exchange option? And what risks do I expose myself to? We’ll show you how convertibles work, why companies issue them and whether the product is suitable for everyone.
What are convertible bonds?
Convertible bonds are Bondswhich give you the right to use them within a pre-agreed period and in a predetermined ratio to swap for stocks. In shares of the company that issued the convertible bond.
In general, give companies with bonds one first credit. From a legal point of view, convertible bonds are therefore Bonds. That is why you occasionally hear the term Convertible bonds.
About the right of exchange, in technical jargon Conversion right or option called, you can make use of it, but you do not have to. Unless you have one Mandatory convertible bond – then you cannot avoid an exchange.
Convertibles have one fixed rate and a limited term. However, the interest rate is lower than with traditional bonds – that is the price for the exchange option. If the term ends and you have decided not to exchange the convertible bond for shares, you will receive the annual interest and the so-called Face value the bond as repayment.
How do convertibles work?
You buy convertible bonds because you hope so cheaper in stocks of the issuing company. Whether that succeeds depends on the so-called Conversion price from, i.e. the price that you have to pay per share if you exercise your conversion right. And of course how the share price is doing. The difference between conversion and market price is called Conversion bonus.
- An example: If the conversion price of a convertible bond is 90 euros, an exchange is worthwhile at the earliest when the share is also traded for 90 euros on the stock exchange. If the share price is lower, the security is cheaper on the stock exchange. If the price on the market is higher, you are getting a bargain.
However, it may be better for you to hold the convertible bond even if the share price is above the conversion price. This is especially the case if you are using the bond significantly higher return achieve than you the Dividend of the stock would bring. The savings that the exchange brought you compared to the direct purchase of shares could then possibly not make up for the missing return.
The exact conditions at which you can exchange the convertible bond is in the so-called Conversion conditions set. You can find this in the Issue prospectus the bond.
Important: The period in which you can exercise your conversion right is not the same as the term of the convertible bond. Usually this ends Conversion period a few days before the end of the term.
Convertibles are a good way for issuing companies to Convert debt into equity. The loan they took out from the buyer with the help of the bond is transformed into issued shares and thus shares in the company. So not only have the company done the interest payments to the owner of the bond, but it doesn’t even have to repay the loan amount.
What are the opportunities and risks?
Convertible bonds combine a fixed rate with possible Price gains of stocks. In the ideal case, you can get stocks cheaper than it would be directly on the stock exchange, and then – if the price develops accordingly – achieve high returns. At the same time, the regular interest payments create a cushion in advance with which exchange rate losses can be cushioned.
But: In the ideal case, of course, you need luck. It is also difficult to find the perfect point to swap because many factors play a role, which are difficult to understand, especially for beginners. But even as an absolute professional, you are not immune to risks.
If you own a mandatory convertible bond, it can too significant losses come when you need to swap the bond at an inconvenient time. And in general, there is also a dependency on the share price with every convertible bond Exchange rate risk. By converting the bond into shares, the capital of a stock corporation can also be diluted, which reduces your chances of return.
Since convertible bonds are Bonds your invested capital is also not considered Special fund protected. This means that if the company goes bankrupt, your money will most likely be completely lost.
Are convertibles suitable for all investors?
No. Convertible bonds are complex financial products, should be reserved for experienced investors. As a beginner, you should decide between the two possible goals of investing: more security at the price of less prospect of returns or higher prospects of returns at the price of less security.
Is you security more importantly, you should be on classic Bonds put. They also bring you even higher interest rates than convertible bonds. On the other hand, are you stronger Return off, you should go straight into shares invest or – even better – in one Equity funds.
Funds have the advantage that you do not put everything on one card, so you spread your risk more widely. However, with funds still come Management fees which reduce your return. You can achieve good returns more cheaply and conveniently with so-called index funds, in short ETFs (“Exchange Traded Funds”).
These are equity funds that use a computer algorithm Stock index like for example the Dax or the MSCI World replicates. ETFs So they develop in much the same way as the index they imitate. A fund manager is not necessary for this, which has a positive effect on income because there are fewer costs.