21st letter to friends of Brunei [Convertible Bond (Part 2)]

2 common questions on convertible bond. One, if you are an investor, "Why invest in convertible bond?" Two, if you are a company, "Why issue convertible bond?" 

Let me first explain:

1. "Why invest in convertible bond?"

I will explain using my experience. Let's take a look on CapitaLand, which share price is currently $4.28. If I were to buy 10 lots (10,000 shares), I need $42,800. My future dividend is not certain. The other way of conservative investment is to buy a convertible bond issued by CapitaLand. I get regular fixed coupon rate and the right to convert the bond into share if I perceive the share to be bullish. 

As compared to warrant, using the convertible bond method will cost substantial capital outlay, but I got to enjoy the fixed income from coupon, and if I don't exercise the conversion right, i still get the maturity par value of the bond. Hence, the downside risk is limited, but the upside potential is unlimited. 

Of course, compare to a normal bond, convertible bond pays me lesser coupon interest. This is fair as I get to have the conversion right. In fact, most corporate bonds issued in the Singapore market are convertible bonds.

In summary, we invest in convertible bond for

1. Fixed income from coupon.

2. Par value at maturity

3. Right to convert into company's share (and profit from it)

4. Limited downside risk (i.e. falling share prices)

And these are the drawbacks:

a. Lesser yield or coupon interest than normal bond

b. Convertible bonds can be "called back"(i.e. redeem) by company before maturity. And in the real world they do get called back frequently.