Over the last several weeks I have been asked to explain the advantages and disadvantages of convertible debentures. As such, I thought that I would provide a brief explanation of the mechanics of these types of securities.
A convertible debenture is a type of debenture that can be exchanged, at the option of the holder, for a specific number of shares of the company’s preferred stock or common stock.
To correctly evaluate the upside potential of a convertible debenture, an investor must start by assessing the potential of the underlying common stock. The value of the convertible debenture is directly linked to the value of the stock. As the price of the stock rises, so will the price of the convertible debenture, and vice versa. If the price of the stock is low (conversion value is smaller than the straight value), the convertible debenture will tend to trade at its straight value and its behaviour will mimic that of a regular debenture. If the price of the stock is high (the conversion value is higher than the straight value), the convertible debenture will to trade like its underlying stock, and its behaviour will mimic that of an equity investment.
Mounir R. El-Ayari, CIM, FCSI, C.h. P. Strategic Wealth
Associate Portfolio Manager