Reverse convertible bonds: For certain interestYou’re looking for an investment that offers regular interest payments and promises a return even when the stock market is weak?
Three reasons for reverse convertible bonds
- Reverse convertible bonds have interest coupons that are well above the usual market interest rates.
- In weak stock market phases, they tend to outperform the underlying assets.
- The products have a risk buffer when the price of the underlying asset falls.
Winners and losers
Fixed interest payment
Reverse convertible bonds are certificates referring to a specific underlying asset and furnished with an interest coupon. As an investor, for the life-time of the instrument you receive a fixed annual interest payment that is well above the usual market level of interest. Another factor is also key to the return: the price trend for the underlying compared to a fixed strike price.
When the instrument matures, there are two options:
1. If the underlying asset is quoting at or above the strike price, you receive the nominal value of the reverse convertible bond 100 percent back.
2. If the underlying asset is quoting below, it is either booked to your custody account with the price loss or you receive a corresponding sum in cash.
When issuing reverse convertible bonds, the strike price tends to be below the current price quoted for the underlying asset. This gives you a cushion of sorts against price losses. If the market moves essentially sideways you can
make a profit – thanks to the fixed interest payments reverse convertible bonds offer. However, if the price of the underlying asset soars, your earnings prospects ae limited – namely to repayment of the nominal value of the reverse convertible bonds plus interest.
Reverse convertible bonds can be traded like any other investment product from 8 a.m. to 10 p.m. The available underlying assets are primarily equities, although in some cases equity indices.