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Convertible Bonds in Today’s Economy

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Convertible bonds are a type of security that offers a steady stream of income but also holds the potential for capital appreciation in the form of a stock. So basically, this instrument functions like a traditional bond by offering fixed interest payments at regular intervals but they also come with a conversion option and the number of shares is predetermined at a specific price.

Convertible Bonds or CBs are a very attractive investment that offers a several advantage for investors. It provides a shield against market downturns with their fixed interest payments, while as we already mention, also offers the potential for capital gains if the company’s stock price increases. These coupon payments may have lower interest rate compared to that of non-convertible bonds because of the added value of the conversion option.

Therefore, in the case that the company performs well, and the stock price climbs above the conversion price investors can convert their bonds into shares and capitalize on the growth. In case the stock price falls, investors have a downside protection and continue to receive their fixed interest payments unlike traditional stock investments.

However, that, CBs carry risks as well. Risks such as dilution of ownership for existing shareholders, as well as the potential for the bond’s conversion feature to become less valuable if the issuer’s stock price declines.

The risk of diluting existing shareholders through convertible bonds had kept many companies away, but bankers are now offering products to reduce the impact.

Typically convertible securities convert into a number of shares of common stocks by dividing the purchase number of the bond plus the unpaid interest by the fixed conversion price of the stocks.

In 2023 the primary market for global convertibles was more than double since 2022, with volumes reaching USD 78Bn via 115 new issues.

Financial Times published an article stating that US companies dive into convertible debt to hold down interest costs. Furthermore, it stated that the boom in convertibles, as a type of bond is likely to continue this year as companies refinance a wave of maturing debt.

A very popular example is that the car sharing group Uber issued a $1.5bn convertible in November at an interest rate of less than 1%. In March, artificial intelligence server maker Super Micro Compute raise $1.7B in capital raise and paid 0% interest rate. This shows that investors adjust to the idea that the Federal Reserve will keep rates higher than they expected this year.

Over the past month a string of prominent Chinese technology groups, including Alibaba and JD.com have collectively raised a staggering $8.3B through the issuance of US dollar denominated convertible bonds.

In current geopolitical climate, Chinese companies are increasingly turning to convertible bonds as a strategic financial tool. This shift is largely driven by the challenges these companies face in accessing traditional equity markets, particularly in the U.S. The strained relations between the US and China, marked by broad financial sanctions and regulatory scrutiny have made initial public offering and follow on share sales nearly inaccessible for Chinese firms.

Finally, convertible debt is getting attention, particularly for high flying mid cap tech companies like Super Micro Computer. The favourable landscape allows firms to borrow under more advantageous conditions, securing lower spreads above risk free rates and indicative cheaper capital compared to periods of market stress.

Irene Rompoti Mavrokefalou
Irene Rompoti Mavrokefalou
Irene Rompoti Mavrokefalou
An ambitious and detail-oriented finance graduate with a solid educational background and diverse professional experience.

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