In volatile equity markets, convertible bonds offer a guaranteed income stream. Investors can exchange the bonds for shares of common stock at a predetermined conversion price.
Some companies use convertible debt to bridge between larger rounds of equity financing. These arrangements typically include a discount rate that limits the company’s dilution.
What is a Convertible?
A convertible is a type of security, usually a bond or preferred shares, that can be converted into common stock. These securities are often used to provide early investors with a stake in the company, while protecting their capital if the company fails. They are also frequently used in Seed Rounds of financing to avoid the higher legal fees involved with traditional Series A Preferred Stock Financing rounds.
Like other bonds, a convertible starts out as debt that the issuing company must pay interest on to the investor. However, in addition to the regular coupon rate, the convertible bondholder has the right to convert the bond into shares of the company’s stock at a predetermined conversion ratio and price level. This feature makes convertible bonds popular with investors that require greater potential for appreciation than traditional bonds, but want the higher income that comes with common stock.
The rate at which convertible bonds can be converted into stock is determined by the conversion metric, which is the number of shares that an investor will receive for each $1,000 of par value in the convertible bond. This metric may be fixed or variable, depending on the terms of the offering. However, it is not always profitable to convert a bond into equity. Consequently, some investors prefer to hold the bond until it matures and then receive the face value of the bond in cash.
Convertible vs. Spider
The difference between a convertible, cabriolet and spider may seem like a minor semantics issue, but it can have big implications if you are buying a high-end open top vehicle. Understanding the differences between these terms will banish any confusion and help you select the best car to suit your needs.
The words convertible and spider have different origins, but both describe vehicles that feature removable roofs. The term convertible is derived from the Latin word convertible, meaning “to convert,” while the word spider derives from the Germanic word spidor. While some manufacturers use both terms, others have settled on one or the other. For example, BMW uses convertible while Jaguar and Mercedes use cabriolet.
Despite the different origins of these words, both convertible and spider refer to two-seat sports cars with a retractable roof. The name “spider” is also used to refer to more expensive and exotic models, such as the Ferrari 488 Spider and the FIAT 124 Spider. However, some automakers, such as Porsche, still use the Y-shaped term for its most hardcore Boxster variants.
In this case, the choice of which name to use depends on the manufacturer and its marketing strategy. For example, Porsche’s RS Spyder is a more hardcore variant of its convertible than the 440 GT Convertible. Similarly, Lancia’s B24 Aurelia Spider is more sought after than the corresponding model’s Convertible.
Convertible vs. Coupe
Coupes are a lot more common than convertibles, especially among high-performance cars. But that doesn’t mean you can’t choose a convertible over a coupe if the car is made in both body styles and you don’t mind paying a premium for the privilege of having the roof open.
Convertibles, or cabriolets as they’re sometimes called, are fun to drive, rain or shine. The fact that you can enjoy the sights, sounds, and scents of nature while you’re carving through curves makes them a very appealing option. The fact that you can get top-down wind-in-your-face excitement and hear your engine’s roar just adds to the appeal.
However, the logical side of your brain will warn you that convertibles are heavier than their fixed-roof counterparts. This is not because of the extra weight of a roof folding mechanism, but rather because when you remove a car’s roof, you also have to reinforce some parts of the frame to compensate for the loss of structural rigidity.
This additional weight can make a difference when it comes to performance, as it can increase the car’s center of gravity and reduce its handling agility. For that reason, convertibles are not typically the preferred choice of performance-car enthusiasts. But for the average person, the experience of hearing exhaust music and tires chirp on upshifts while feeling the sun and wind on your face is more than worth an extra tenth or two in the 0-60 time.
Convertible vs. 500
The convertible market has evolved from the rags-to-riches 1950s Cadillac Eldorado Biarritz into a global asset class, with as much as $525 billion in value as of June 30, 2021 (Figure 6.1). Like other investment assets, convertible securities exhibit dynamic trajectories, with their attributes varying significantly over time and depending on macro conditions.
Like stocks, convertibles have the potential to appreciate in rising equity markets and are less sensitive to rising interest rates than bonds. On the other hand, they are subject to declines in their underlying common stock that can affect both the conversion price and investment value of the security.
Convertible issuance has a strong correlation to economic growth and often serves as an alternative form of financing for companies with limited equity IPO windows. In addition, because convertibles are a hybrid security with characteristics of both stocks and bonds, they can offer attractive yields compared to non-convertible debt during periods of rising interest rates.
The structure of a convertible may vary, with the conversion terms and conditions defined at the time of issuance by the issuing corporation. In particular, mandatory convertibles, which automatically convert to shares of the issuing company’s common stock at a set time, are a key part of the market and typically have enhanced equity characteristics.