Converting Bonds

Converting a bond is based on par value and the fixed conversion price that appears on the bond. The conversion price is not the price the stock is purchased at. So, it is unlike a "Stock Option". The time to convert is the investor's choice. An example:

A customer owns ABC convertible bond that is selling in the market at $1040 or $104, the common stock is selling at $54 and the conversion price is $50. The investor would like to convert, but will only do so when the stock value is trading above the bond value. "Parity" would occur when the bond and stock are equal. The first thing you must find out is the amount of shares the customer is entitled to. We get that by dividing the conversion price into the par value of the bond ($1000). $1000 divided by 50 equaly 20.

The investor can convert out of the bond into 20 shares of stock - no more no less. The stock is currently trading at $54, so the the stock value is found by multiplying 20 (shares) by $54 (stock value), which equals $1080. $1080 is above the bond selling price of $1040, so converting at this time would meet the customer's objectives of converting only when the stock value was above bond value or "above parity".

Pricing Convertible Bonds - The Convertible Bonds (CB) market is growing all the time. To date, over one trillion dollars worth of CBs are in circulation. Corporations are finding this source of fund-raising more and more attractive. And for different reasons, the buyers are finding CBs increasingly attractive investment vehicles.

There are few works on the subject of pricing convertible bonds. Most books discussing derivative products cover all details of pricing futures and options in minute detail. Convertible bonds and warrants are usually mentioned as an after thought in the latter chapters. This is the first book to address the very complex issue of pricing convertible bonds.

Who Owns Corporate Bonds?

With the current debt and interest rate conditions - I was wondering who is holding corporates now. The junk bond market was always a good play for most investors as there were very few defaults.

I think the Stock Market will be down another 10% by year end. Just my opinion. Seeing where others are at with this.

Nick
American Investment Training
Financial Glossary

Agency Bonds

Types of Agency Bonds

Straight Debt Obligation - These bonds are backed by the full faith and credit of the agency and generally pay interest from a nominal yield every 6 months with a fixed maturity where the par value is redeemed. These are typical structures that are common in other forms of issuers, such as corporations and municipal issuers.

Pass Through Securities - These bonds are backed by the full faith and credit of the agency as well, but the payments and eventual pay-off rely on the paying back of mortgage payments issued through the agency. Ginnie Mae or another mortgage issuing agency could issue a pass through to fund the issuance of mortgages to a group of people. As the homeowner pays back principal and interest back to Ginnie Mae, Fannie Mae or whoever - the bond holders are paid.

Pass Through Bonds or Mortgage Backed Securities are normally issued as 30 year bonds, but the prepayments made by the mortgage holders or changes in interest rates will effect the speed of the payments made on the bonds. The holders will receive monthly principal and interest until their share in the bond is completed.

These bonds have a large amount of prepayment (paying too fast) or extension risk (paying too slow), because changed in interest rates, will have a potential volitile impact on the performance of the bond.

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CMO Bonds

Collateralized Mortgage Obligations differ from pass through securities in that they have different types of paying bonds within the CMO. There are many types and tranches to evaluate - each with it's own bond risk.

A CMO has different payment timing risk depending on the type of bond you own. Some offer more protection than others from prepayment or extension risk. These bonds have a more predicatable duration to the bondholder vs. a pass through agency bond. Some CMO's can pay off faster than others.

Learn much more on investing and trading these bonds. Free Info through American Investment Training

CMO INVESTING PAGE