Convertible bonds
Bonds with conversion rights are called "convertible bonds". For a limited period of time, they give the lender
the right to convert the bond into a predetermined number of equity securities such as shares. If
the conversion right is exercised, the lender's status changes from that of a
creditor (provider of outside
capital) to that of a shareholder
(provider of equity capital). If the conversion right is not exercised, the convertible
bond behaves in the same way as a conventional bond. The option of converting it into equity
securities constitutes added value for investors, so the interest rate is usually a little lower.
The terms of the issue may also stipulate that the bonds have to be converted by a certain date.
Investors can benefit from investing in convertible bonds in a number of different ways. On the
one hand, there is an unlimited potential for price gains in the event of rising shares prices;
on the other hand, there is a limited risk of loss, because apart from the conversion right, a
convertible bond is really the same as a conventional bond. Convertible bonds are typically
issued by joint-stock companies.
The following criteria may be relevant to investors when buying convertible bonds:
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Criterion
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Description
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Preferential subscription right
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Under the Swiss Code of Obligations (CO), if convertible bonds are issued in the context
of a conditional capital increase, they must first be offered for subscription to the
company's existing shareholders in proportion to their existing stakes.
This preferential subscription right may be restricted or denied on important grounds.
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Yield
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The interest rate on convertible bonds tends to be a little lower than that offered by
conventional bonds. The share price of the company whose shares can be subscribed
influences the price of convertible bonds.
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Conversion ratio
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The conversion ratio indicates how many equity securities (shares) the lender receives for
a certain nominal value of the convertible bond. For example, if one convertible bond can
be converted into 100 shares, the conversion ratio is 1:100.
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Conversion period
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The period during which an investor can carry out a conversion is called
the "conversion period". It usually begins some time after the time of
issue (e.g. six months later) and often ends on the maturity of the convertible bond.
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Conversion price
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The nominal value is often used to calculate the conversion ratio. However, the issuer may
also use a higher or lower price, which results in a
premium or a
discount. The issuer specifies the
conversion price when issuing the convertible bond, but the price may be
adjusted later.
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Anti-dilutive provisions
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Under the Swiss Code of Obligations (CO), when new conversion rights are issued, existing
conversion rights may be diluted only if the same dilution applies to the shareholders.
Otherwise, the conversion price must be lowered or other suitable compensation
has to be given to the beneficiaries.
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Call right
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The terms and conditions of the issue may stipulate that the bond issuer can call the
convertible bond unilaterally once a certain share price is reached. In
this case, the investor could be required to convert early. Other conditions are
possible as well.
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