Discussion Questions 1: In the capital market environment we are now in would you invest in convertible securities? As a corporation, would you sell convertible securities? Do you perceive any conflict between the goals of the investor and the corporation?
Post 1 (Kat-Jos)
In the capital market environment, we are now in would you invest in convertible securities?
Convertible bonds give the investor the ability to convert bond into shares of common stock and vice versa. Investors will convert their bonds when the market price of the stock is greater than the conversion price, to generate a profit. Its flexibility in finance options, is the main reason why investors tend to choose this type of security (Buumann, n.d.). Corporate bonds have a higher yield than convertible bonds.
Also, the relationship between the convertibles and stocks supports it during low interests. A volatile market can help increase the value of the stock through its price (Cornelli & Yosha, n.d.). The low yield rate is a benefit for both the investor and the corporation selling the convertible bonds. The benefit for the corporations is that these bonds have low capital yields, which allows the corporation to gain capital. For the investor, this type of investment is attractive because I can invest in convertible securities given that a convertible security gives me as an investor a great deal of flexibility and less risks with a guaranteed divided or coupon payment. Also, it allows the investor to take advantage of larger returns through the conversion of the security into common stock. This option provides an opportunity to gain capital, and with the changing interest rates in the economy at present; investors are looking for options that provide the ability to gain capital on their investment.
As a corporation, would you sell convertible securities?
As a corporation, I would sell convertible securities because convertibles provide the opportunity to retain working capital for the corporation, and convertible security holders receive a limited return until the bond is converted. The advantage to the corporation are; more operating income for working capital and to pay common stockholders, and convertible shareholders are not entitled to voting the directors.
Do you perceive any conflict between the goals of the investor and the corporation?
Yes, I do perceive conflict between the goals of the investor and the corporation. If weaker corporations issue convertible securities to reduce their finance costs they may never have the capital when the bonds are submitted by the investors for conversion. Investors are looking for growth and higher returns, that is the idea of investing for most investors. The attraction to convertible bonds is that; This type of a flexible bond can help the investor convert into the number of shares they want, with the set interest and earn principal(Woronoff & Rosen, n.d.). However, the attractiveness of convertible bond investments can sometimes be deceiving. If weaker corporations, have visible potential for growth that creates an attraction for investors. The growth potential creates higher conversion projections which, in turn, creates an attraction for investors. Usually, when capital earnings are low, and there is growth in stock price, company’s issues convertible securities to reduce their cost of receiving scarce capital. This may frustrate the investor because the investors make more money on a bond conversion at stock price. If the growth feature is attractive enough, weaker companies can potentially sell convertible bonds at a price that is higher than the common stock price, which is more expensive for the investor. If the return is not as high as anticipated, the investor may risk the rate of their return on their investment in the corporation’s convertible bonds.
Buumann, R. Evaluating Contingent Convertible Securities. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.2472565
Cornelli, F., & Yosha, O. Stage Financing and the Role of Convertible Securities. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.322460
Post 2 (Jos-Cr-Rav)
A “convertible security” is a security—usually a bond or a preferred stock—that can be converted into a different security—typically shares of the company’s common stock. In most cases, the holder of the convertible determines whether and when to convert. In other cases, the company has the right to determine when the conversion occurs.
Companies generally issue convertible securities to raise money. Companies that have access to conventional means of raising capital (such as public offerings and bank financings) might offer convertible securities for particular business reasons. Companies that may be unable to tap conventional sources of funding sometimes offer convertible securities as a way to raise money more quickly.
A market price based conversion formula protects the holders of the convertibles against price declines, while subjecting both the company and the holders of its common stock to certain risks. Because a market price based conversion formula can lead to dramatic stock price reductions and corresponding negative effects on both the company and its shareholders, convertible security financings with market price based conversion ratios have colloquially been called “floorless”, “toxic,” “death spiral,” and “ratchet” convertibles.
I Don’t perceive any conflict between the goals of the investor and the corporations. Nobody competes in the securities market unnoticed for the risks involved. Investors and companies assume their share of risk and go for the same purpose in that bet. US Security & Convertible Securities provides security and information to lessen the risk effects that both investors and companies are exposed to. Both investors and companies should understand that market price based convertible security deals can affect the company and possibly lower the value of its securities.
Changes and potential changes in monetary policy across the globe, along with increased volatility in currency and equity markets, have thrown a spotlight on convertible securities, described by some as offering the “best of both worlds” in terms of stock and bond characteristics. Investors would look for ways to reduce their downside risk from exposure to the effects of the changing interest rate outlook on equities, bonds and foreign currencies. In an attempt to achieve that goal, some investors have turned to convertible securities. Issued by companies looking to raise capital, these are hybrid instruments that can be structured as either debt—such as bonds, notes or subordinated debentures—or as some form of equity, such as preferred shares. Owning a convertible gives the holder the right to convert it into a certain number of shares of a company’s underlying stock under predetermined conditions (Muschott, 2014).
Convertibles can offer participation in the capital appreciation potential of common stocks while the bond component provides interest payments and a claim to principal. If a company’s common stock rises, the convertible security should increase in value because of the price relationship with the common stock. If the common stock doesn’t perform well, the bond component should help soften the potential downside (Muschott, 2014).
Muschott, A. ( 2014). Thoughts on Investing in Convertible Securities. Franklin Templeton Investments. Retrieved from: http://us.beyondbullsandbears.com/2014/05/07/thoughts-investing-convertible-securities
Convertible Securities. US Securities & Exchange Commission.https://www.sec.gov/fast-answers/answersconvertibleshtm.html