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Exchangeable vs. Convertible bonds
An exchangeable bond allows a bondholder to interchange or trade their bond, for the stock of a company other than the issuer (may be a subsidiary). Exchangeable bond gets matured into three to six years. Convertible bonds give the option to the bondholder to trade the bond against other securities (like stock) that the issuer has.
Some examples and terms:
These examples and terms will clear some basic concept and will help you to in your assignments.
Let’s discuss a case of exchangeable bonds with exchangeable ratio. For example, suppose a Company (Named ABC) bond has an exchangeable bond into shares of another company DEF at an exchange ratio of 40:1. (DEF is a subsidiary company to ABC)
This will mean that one can exchange every $400 of per value owned by the person of ABC bond into 40 shares of company DEF stock. Hence, the person can buy company DEF bond for $10 per share ($400/40). Again, if the company DEF starts to trade for $30 per share, the person would exchange the bond and will sell the share with a profit of $20 per share.
But if the company DEF trade their share less or equal to the price of $10, then the person would not receive any extra incentive by exchanging the bond. But he/she can receive coupon payments. It would be an intelligent idea to get these coupon payments as the person would have still a chance to have some profit after the stock value increase.
The ratio of conversion:
This ratio tells us the number of shares that can be converted or transformed from a bond. This also can be explained as a ratio. For example, if the ratio of conversion is 50:1 that will imply that a bond (with $500 per value) can be traded for 50 stock shares.
Example of convertible bond:
Suppose a company ABC bond with a $500 per value convertible into Company ABC common stock. It has 5 % coupon, annually payable. Now if the conversion ratio is 10. Then the investor will buy 10 stock share of ABC for $50 per share ($500/10). If the share value increases and the bondholder keep the bond for multiple years, then his per share investment will undoubtedly increase.
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