Investing in convertibles, preferred stocks, and warrants

Abstract

[Chapter Introduction and Objectives]: Convertibles are derivative embedded, hybrid instruments that get converted into the issuer's equity after some time at the option of the holder. The worldwide market for convertibles has grown enormously. In this chapter, we discuss the rationale for and the valuation of convertibles. We also compare convertibles with debt-warrant packages and preferred stocks. This chapter has the following objectives: • Highlight the factors responsible for the growth in convertible issuance • Discuss the design and valuation of convertible bonds • Introduce stock warrants and preferred stocks A convertible bond, as opposed to a straight bond, gets converted into a fixed number of shares of the issuing company at a pre-specified price. The holder of a convert is entitled to receive interest on the convertible portion till conversion. Thus, a convert is a package of straight debt and equity option. The option to convert is usually at the discretion of the holder and will only be exercised when and if the holder finds such an exercise desirable. The features (terminology) of a convertible bond are discussed below.