Product Know-how

Reverse Convertibles - A Plus With Interest

Purchasing a reverse convertible or indexed bond is a good idea if...

... You are assuming a sideways or slightly rising stock market and also want to obtain regular interest payments independent of the market.

A reverse convertible brings you a regular return above the interest level of the market for a certain time period. In addition, you have a holding in the performance of the underlying asset. Individual issues offer special constructs which provide/endow reverse convertibles with barriers. These give the product additional security.

Reverse convertibles are a perfect mixture of the typical characteristics of a bond and the characteristics of a share. A bond because the buyer receives regular interest payments during the reverse convertible’s duration. A share because the development of the underlying asset determines the type of repayment at maturity. If the share is quoted at or above the agreed strike price at the end, the amount of the bond paid in cash at the beginning is paid back. If the price of the share falls below the fixed price level, on the other hand, a previously determined number of shares will be delivered. This demonstrates that a reverse convertible may aim for a constant return independent of the market during its duration, but the development of the underlying asset still plays a role.
Reverse convertibles are a special form of bond. They belong to the category of classic bonds. Either the nominal amount is paid back or a specific, previously determined number of shares is delivered as repayment. The decision lies with the issuer or the company that issued the bonds. Since they function exactly opposite to convertible bonds, they are called “reverse convertibles.” Investors interested in a reverse convertible should familiarise themselves with the specific bond conditions before purchase. These provide exact information about the characteristics of a reverse convertible. Such information might include the nominal amount, the interest rate, the number of shares, and above all, the strike price. The latter determines whether an investor receives the sum or the shares when the reverse convertible reaches maturity. If this strike price falls below the share price on the call date, the investor receives the shares. If the strike price is equal to or greater than the share price, the nominal amount is paid out. Reverse convertibles can be bought and sold on the stock market at any time before maturity.