In recent years, especially since 2018, the yield on bonds in our country has been declining year by year. Along with the pandemic, multiple monetary easing policies have brought several waves of bond market trends, while also having to face the embarrassing situation of a year-by-year decrease in bond coupon rates. Under such circumstances, investment institutions have proposed the "fixed income +" strategy, and convertible bonds are the most common "plus assets."

What is a convertible bond?

A convertible bond, fully known as a convertible corporate bond, refers to a bond issued by a listed company that can be converted into the company's stock under certain conditions.

First and foremost, a convertible bond is a bond with the fixed-income characteristics of a bond, with a face value of 100 yuan, receiving the coupon interest during the holding period, and the face value principal can be redeemed upon maturity. At the same time, because the terms of the convertible bond grant the holder certain rights (options), this right is that the convertible bond can be converted into stock and sold under certain conditions, enjoying the price difference between the conversion price and the selling stock price. Its returns are linked to the price fluctuations of the underlying stock, which is the so-called equity nature. This equity nature is realized through options, and options are not a free lunch; they are obtained by sacrificing a certain amount of coupon interest.

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The demands of both parties in convertible bond financing and investment:

1. Financer: To reduce the difficulty or cost of financing

Listed companies need a large amount of capital for rapid development, and relying solely on equity financing is far from enough. They may seek financing from banks or issue ordinary bonds, but the interest rates are high, and in recent years, the difficulty of issuing some corporate bonds has increased. To reduce interest rates and achieve financing, choosing to issue convertible bonds with lower interest rates can stimulate investors' enthusiasm for purchase, and grant certain options to bond investors, or rather, a certain imagination space.

The moment the convertible bond is successfully issued, the financer's goal has been achieved. When the sold option is exercised, the listed company's bonds are converted into shares, saving the funds for debt repayment. The excess returns for investors are realized from the secondary market of stocks, and apart from diluting shareholders' equity to a certain extent, the listed company itself does not incur additional costs.

In general, if a listed company already has the need for equity financing, and the conversion price is in line with the interests of the original shareholders, then issuing convertible bonds is the optimal strategy for the listed company to leverage its strength.

2. Investors: To seek imagination spaceThe bond yield is determined, but unattractive; stocks carry high risk, which one dares not undertake, leading to a state of dilemma. Although convertible bonds are imagined to offer yield potential in exchange for coupon interest and long duration, there are two direct perceived advantages:

First, there is a safety net on the downside. On one hand, there is the maturity face value payment as a guarantee (with credit risk analysis being the same as for pure bonds), and on the other hand, there is the pure bond value as a cushion, ensuring a certain level of return.

Second, there is no cap on the upside. Because they possess characteristics of stocks, they have the potential to double or even multiply many times in value.

3. The Essence of Financing and Investment Demands

It can be seen that the coupon interest and options are the chips exchanged between the two parties, and the process of their quantification is a game between the issuer and the investor, with each party taking what they need.

Convertible Bond Analysis Indicators

In the convertible bond trading interface, one can observe numerous indicators used for investment analysis.

(1) Underlying Stock: The stock corresponding to the listed company that issues the convertible bond is referred to as the underlying stock.

(2) Price: Refers to the real-time fluctuating price of the convertible bond in the market.(3) Conversion period: The conversion period typically begins six months after the issuance of convertible bonds, which means that convertible bonds not yet in the conversion period cannot be converted into shares, implying that there is a certain debt-holding process required.

(4) Conversion price: The conversion price is the core of convertible bonds, colloquially speaking, it serves as a bridge between the convertible bonds and the corresponding stock. The conversion price and the secondary market price of the stock determine the conversion profit of the convertible bonds. If the secondary market stock price is lower than the conversion price, then conversion would mean a loss.

(5) Conversion value: = (Face value / Conversion price) x Stock price, it measures how much money each convertible bond can be converted into shares at a certain point in time and then sold, based on the conversion price. It is mainly used as a reference indicator to measure the rationality of the secondary market price of convertible bonds.

(6) Conversion premium rate: = (Convertible bond price - Conversion value) / Conversion value x 100%, it is used to measure how much more expensive the convertible bond price is compared to after conversion. A positive premium rate indicates that the convertible bond is more expensive than the stock, while a negative rate indicates that it is cheaper. This parameter is very important in actual investment, but in reality, it is not as simple as it seems.

(7) Issued/Remaining scale: The issued scale refers to the amount of convertible bonds issued by the listed company corresponding to this code. The remaining scale refers to how much debt has not been converted after a period of conversion. The secondary market trading of convertible bonds does not affect the remaining scale; if the convertible bonds are converted, the remaining scale will decrease.

Due to the current high popularity of convertible bonds, there is generally a premium situation. That is to say, the price formed by the secondary market trading of convertible bonds is higher than the conversion value, and the conversion premium rate is positive, which means that the purchase price is higher than the value of the underlying assets it corresponds to. This should be considered as a premium for the type of bond, or a premium for an option.

Risks of convertible bonds:

We mentioned earlier that convertible bonds have a bottom guarantee and no upper limit, but this also has certain limitations. During the investment process, due to incomplete understanding of the terms, there are some risks that may be faced.

1. Mandatory redemption clause

The phrase "no upper limit" refers to the unlimited potential for the stock price of the underlying stock to rise, but convertible bonds may bring investment losses to investors due to the presence of a "mandatory redemption clause."During the conversion period, if the company's stock price closes at or above 130% (inclusive of 130%) of the current conversion price for at least fifteen trading days within any consecutive thirty trading days, the listed company may choose to redeem the convertible bonds with "par value + current interest." If investors fail to seize the opportunity to convert, triggering a forced redemption clause, it could result in a reduction of approximately 30% in returns. If the convertible bond is purchased at a premium, there may even be a loss of principal.

2. Risks of Premium Purchase

The safety net of convertible bonds (assuming no default) is that the principal and interest can be recovered upon maturity, but this principal and interest refer to the face value. Therefore, the premise of capital preservation is that the purchase price should not exceed the total amount of the principal and interest. In the current market environment, there are fewer convertible bonds priced below 100 yuan. However, it is possible to buy new bonds through the initial offering.

At the same time, at certain points, individual bonds may experience a market price that falls below par value, known as a break-even. Selling at this time would also result in a loss.

Newcomers to convertible bonds: Initial Offering

Participating in the initial offering of convertible bonds involves subscribing to bonds that are about to be listed. The threshold for subscribing to new bonds is relatively low, and most stock trading software includes an entry point for both new stock and new bond offerings.

If sold on the day of listing, earnings can range from a little over 100 yuan to 300-500 yuan, with a return rate of 10% to 50%. However, there is also the possibility of a break-even on the first day of listing. Considering that the time from payment after winning the bid for convertible bonds to trading after listing is only about a week, the capital is tied up for a short period, making the annualized return rate very attractive.