risk/return profile of the convertible security, Financial Management

Let us consider three scenarios of changes in stock prices and look into the risk return profile of the convertible security. Let us assume that the stock prices remain same, increase and decrease. When the stock prices remain the same, even if a premium is paid to acquire the convertible issue, stock position would under perform the convertible position. This is due to the income from coupon which compensates the capital loss. When the stock prices decline, as the straight value provides a floor for the convertible, the convertible position outperforms the stock position. This analysis is made assuming that the straight value remains same and does not change except for the passage of time. But, in reality as the interest rates increase the straight value will decline. Like any other instrument, convertible securities also have advantages and disadvantages. The disadvantage is that the upside potential is given-up because of the premium paid on every share but on the other side, it helps in reducing downside risk.

Posted Date: 9/10/2012 8:03:18 AM | Location : United States







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