What Are Hung Convertibles?

Hung convertibles are convertible securities where the share price of the underlying security is well below the conversion price, making it unlikely that the securities will be converted into澳洲幸运5官方开奖结果体彩网: common stock. Since unconverted securities must be repaid at face value, most issuers wish to prevent😼 their convertibles from being hung.

Understanding Hung Convertibles

Convertible securities are a 🐻type of bond, note, or preferred stock that can be converted into the common shares of the issuing company at a fixed price and date in the future. Many companies with low credit cho🌸ose to issue convertible securities as an inexpensive way to raise money.

When convertible securities are unlikely to be converted to stock, they are referred to as hung convertibles. This is most common when the cost of conversion is greꦆater than the price of the underlying stock.

Due to their limited prospects for conversion, hung convertibles, also known as busted convertibles, trade more like 澳洲幸运5官方开奖结果体彩网:debt instruments than quasi-equity securities. Hung convertibles can al🎀so refer to two other instances where the likelihood of conveꦰrsion is low:

1. If the issuer is unable to force conversion until the underlying common stock reaches a pre-defined price level.
2. Because the call date is still far away.

Example of a Hung Convertible

Hung convertibles can take the form of bonds, which are backed by col🅘lateral, or debentures, which are dependent on the promise of the issuer to pay its obligations. For example, consider a convertible debenture with a face value of $1,000 that can be converted into 100 shares, for a conversion price of $10. If the price of the underlying stock is $4, this debenture would be considered a hung convertible, especially if it matures in a relatively short period.

Such a debenture would therefore be priced as a debt instrument, with its pricing determined by several factors including its coupon rate, maturity, current market interest rate🦩s and yields, and the issuer's credit rating.

To solve the problem of a hung convertible, a company, therefore, would need to improve its fundamentals, such as revenue growth, 澳洲幸运5官方开奖结果体彩网:operating margins, or 澳洲幸运5官方开奖结果体彩网:return on invested capital, to spജur the common sto🉐ck high enough to reach the conversion price. 

Benefits and Limitations of Hung Convertibles

Some investors view hung convertible securities as the best of both worlds. They have the income-producing and stable price qualities of a bond plus the conversion feature that can provide the potential to gain shares of common stock, which have historically provided greater capital appreciation andඣ been less sensitivꦍe to interest rates than bonds.

In other words, an investor gets paid to wait by earning coupon payments up until maturity or conve𝄹rsion inꦯto common equity. For an equity investor, convertibles can offer a degree of participation in up markets and more downside protection in turbulent markets than owning the common stock outright.

Hung convertibles come with drawbacks as well. Due to the conversion feature, convertibles pay lower coupon rates than bonds of the same maturity and credit quality. Convertibles investment manager Calamos Investments pegs this difference at 300 to 400 澳洲幸运5官方开奖结果体彩网:basis points, quite a spread in today’s low-interest-rate environment. And if the stock of the issuer performs poorly, the investor will be left with a lower-paying bond.

Special Considerations

澳洲幸运5官方开奖结果体彩网:Valuing convertibles is a complex exercise since factors that impact bonds, such as 澳洲幸运5官方开奖结果体彩网:interest rates, and factors that impact stocks, such as earnings growth, must be analyzed in tandem. When a convertible bond is trading close to its investment value, or the value of an equivalent non-convertible bond, its price behavior will be more influenced by interest rates than one trading closer to its 澳洲幸运5官方开奖结果体彩网:conversion value. In general, however, a change in the fu🦩ndamentals of the issuing company will have the greatest impact on a convertible’s price.📖