What Is a Premium Put Convertible?

A premium put convertible is a type of bond that combines the features of put bonds with the attributes of 澳洲幸运5官方开奖结果体彩网:convertible bonds. Like a put bond, a premium put convertible can be redee𒈔med for cash at the discretion of the bondholder. Like a convertible bond, a premium put convertible can be converted into shares of the company's stock at a preset rate.

Understanding Premium Put Convertibles

Figuring out how the put feature works is the first step to understanding premium put convertibles. A 澳洲幸运5官方开奖结果体彩网:put option gives the owner the right, not the obligation, to sell a security at a specified price within a defined timeframe. Like a put option on a stock, this feature includes a 澳洲幸运5官方开奖结果体彩网:strike price. The strike price is a 🌼valu🐻e at which a specific derivative contract can be exercised.

The strike price for an ordinary put bond will typically be below the issue price of the bond. However, a premium put convertible allows for an alternate arrangement where the strike price is higher with restrictions on when the 澳洲幸运5官方开奖结果体彩网:embedded put can be exercised. For example, the market price of the bond or the company's shares might have to rise above a certain level. In cases where stock and bond prices rise, the company should find it easierಞ to pay off bondholders.

The other half of understanding premium put convertible bonds is learning how the 澳洲幸运5官方开奖结果体彩网:convertibility trait works. Convertibility allows the bondholder to convert the bond into an agreed-upon number of shares of the underlying stock. The ratio at which the bond exchanges for shares is the 澳洲幸运5官方开奖结果体彩网:conversion ratio. The conversion ratio is determi♈ned at t🎶he time of issue and impacts the relative price of the security. The conversion involves no exchange of cash or funds, only shares of the underlying asset.

Premium put convertibles can only be converted on a single day. However, rolling put convertibles are able to be converted🌃 on multiple dates.

Advantages of Premium Put Convertibles

Premium put convertibles seem to offer investors an ideal combination of limited losses and unlimited gains. Theoretically, the put feature can protect investors if the issuing company does poorly. If the issuer does well, the convertible feature allows premium put convertible bonds to be exchanged for the company's stock.

Disadvantages of Premium Put Convertibles

The first disadvantage of p🌼remium put convertibles is their low-interest rates. Obviously, having protection in the form of a put and potential for higher returns due to stock convertibility are desirable features. These features come at a cost, and that cost usually comes in the form of lower interest rates.

The second issue is the construction of the put feature. A typical put bond has the strike price set below the bond's issue price, and it can be 澳洲幸运5官方开奖结果体彩网:exercised to limit any losses that might occur. The story is different for a premium put convertible with restrictions requiring the bond's market price to reach a higher strike price♔ before it can be exercised. If the company does poorly, the bond price might never rise to the strike price. In that case, the put provides no protection because it cannot be exercised.

Finally, the interesting features of premium put convertibles can be duplicated using 澳洲幸运5官方开奖结果体彩网:exchange-traded funds (ETFs) and options while reducing risks. For example, an investor might buy a bond ETF, buy a put on it to limit downside potential, and buy a 澳洲幸运5官方开奖结果体彩网:call option on a stock ETF. Like premium put convertibles, such an arrangement reduces maximum losses and allows for more gains, but it also benefits from more 澳洲幸运5官方开奖结果体彩网:diversification.

Example of a Premium Put Convertible Bond

Consider an investor who owns ꦦa premium put convertible bond with a face value of $1,000, a coupon rate of 4%, and a put feature at a strike price of $1,200. Suppose that the put feature also has a restriction requiring the market price to reach the strike price before it can be exercised. Finally, each bond can be converted to 10 shares of the underlying stock of XYZ company.

With one year left before maturity, the bond reaches its strike price of $1,200. The investor may then exercise the put option and sell the b🌄ond back to the issuer at $1,200. Alternately, the bondholder may convert the bond to 100 shares of XYZ stoc🌳k. If the XYZ share price goes above $120 per share, this would be an attractive option.