Convertible bonds present investors with a unique opportunity to convert bond holdings into a common stock position of the issuing company. Convertible bonds share a number of similar characteristics with traditional bond issues such as maturity dates, principle repayment schedules, quality rating of credit and predetermined coupon payments.
Investing with convertible bonds provides an attractive risk/reward profile through the benefits of fixed income streams in the period leading up to maturity, at which time the principle value of capital is repaid with an option to convert the security's status into equity.
Enhanced with Equity-Like characteristics
Combining the components of fixed income and equity-like characteristics provides a degree of downside risk with the increased potential of upside performance.
However, in light of the upside potential presented through the equity status conversion, convertible bond strategies often restrict the initial value of bond coupon payments as repayments are determined by both the equity stock price and the fixed income value.
Performance of convertible securities under normal market conditions presents investors with the benefits typically sought by the lower risk profiles found in traditional corporate bonds, which in turn, are compounded by the additional benefits returned by equity holdings. Incorporated as part of a diversified portfolio, convertible securities offer an attractive hedge over the fluctuations of stock prices and bond coupon payments.
In consideration of these benefits, and in light of increasing levels of market unpredictability, allocating convertible bonds as part of an opportunistic portfolio component is becoming a common practice for investors seeking volatility-adjusted returns.
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