Greatest Care must be taken in Buying Convertible Bonds

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Some common popular bonds in the market in recent years are the

  • convertible issues and 
  • bonds with warrants to buy stock attached.
Convertibles are popular because they seem under certain conditions to combine 
  • a degree of bond dollar safety 
  • with a chance of profit.
Profits can be made by careful selection, pricing and timing of these bonds.
Market price of convertible bonds
The market price of a convertible bond is a 
  • combination of estimated true current investment value
  • plus a premium for the current value of conversion privilege, if any.  
This premium varies with 
  • the estimated opportunity to make a profit, 
  • the length of time the privilege runs and 
  • other factors.
The greatest care must be taken in buying convertibles.
The most common mistake is to look too closely into 
  • the size of the premium or 
  • the closeness of the conversion price on the bond to the current market for the stock into which it can be converted.
You should look first into the stock for which it can be exchanged.
  • If you care to make a profit, this must go up.  
  • You must start by being fundamentally bullish on the equity.  
  • Only then can you look into the mathematical factors governing the price of the convertible bond.
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