Convertible And Reverse Convertible Bonds: The Basics

Bonds are issued by the issuer or buyer to the creditor. If the market value of the collateral or amount of the bond increases, then the value of the convertible bond also goes up. Similarly, if the value of the material on which the bond has been issued decreases, the bond will also decrease in price. Convertible and reverse convertible bonds are similar with one exception- the role played by the underlying company.

Convertible Bonds:

Convertible bonds are, as the name suggests, convertible. You can change them into another kind of bond or equity at a certain time, and within certain limits. You must remember that the convertible bond has some value apart from what the conversion feature gives it. Many companies that deal in bonds prefer the convertible bond, as its flexibility means that it can be converted into equity, reducing the cash burden on the company. That is, if the issuer of the bond decides to convert his or her bonds, then he or she simply buys shares of the issuing company.

Reverse Convertible Bonds:

Reverse convertible bonds are similar to convertible bonds except in one feature- while the convertible bond allows the issuer to invest more in the issuing company; the reverse convertible bond allows the issuer to hold shares in the company. The advantage reverse convertible bonds have over convertible bonds is that they are more profitable and mature in shorter time.

For example, consider the bond issued by a bank over what it owes in debts to a company. The bond may yield substantial amount through shares, but if the company's shares decrease in value, then the bank can put up the shares of the company to the party that holds the bond. In that case, the bank need not pay cash during the time of the bond's maturity.

Conversion Ratio:

The conversion ratio refers to the number of shares that can be converted from a bond into another form of debt or equity. This is specified at the time of the issuance of the bond.

Risk:

Convertible bonds, like all bonds, carry a risk option. While companies give lower yields on convertible bonds, the issuer can benefit from an increase in the stock value of the company and convert the bonds to shares. However, if the company's stock decreases in value, then the issuer has a low yield bond on his hands.

If you are unsure of the dynamics of the convertible bond vis-à-vis the market, or want to know more about how they work, you can approach any financial consultant for help. If you are an entrepreneur or run a small-scale business, then it is crucial that you know about the options, you have regarding convertible and reverse convertible bonds. Many small-scale business consultants can help you decide your bond options. It should be remembered that while convertible and reverse convertible bonds have certain risks, they also yield high returns if you invest wisely.

Alexander Gordon is a writer for http://www.smallbusinessconsulting.com - The Small Business Consulting Community. Sign-up for the free success steps newsletter and get our booklet valued at $24.95 for free as a special bonus. The newsletter provides daily strategies on starting and significantly growing a business.

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