Q: Hi Peter and 5i: a couple questions about convertible debentures (“CDs”) and also could you please let me know if anything that I am saying suggests I may be misunderstanding these instruments. First off, it seems there are two typical situations that result in CDs trading above their face value. One is if the common share price appreciates to the point where the CD’s are primarily of interest for their potential conversion value. I’d like to leave this aspect aside, as right now I am more interested in their characteristics when they are behaving more like bonds. The second situation seems to occur mostly when they get relatively closer to their maturity dates. I would guess this is an effect of their relatively high original yields in combination with the fact that the perceived default risk can decline more steeply and from relatively higher levels for these corporate debt instruments than for “safer” fixed income alternatives. If they are issued with 6 or 8 years to maturity, that is a long time in the world of corporate business and who really knows how some of these companies will do over that kind of timeframe. On the other hand, in a CD’s last year before maturity, the visibility of the solvency and continued existence of the corporate issuer may be extremely good. With a short enough time to maturity, one might even think that the default risk is not materially worse than with government backed securities, that is, probably still somewhat worse but the overall risk is small enough that the difference is not that significant. So my first question is: Is it common for professional money managers to purchase CDs with short remaining maturities in order to boost short term yields in their fixed income funds? Would that be a significant component of what causes CDs to trade above par as their maturity dates get nearer?
Second question: Are there any standard “catches” or pitfalls in the construction of individual CDs that retail investors really need to be watchful for? I know it is important to go right to the filed prospectus document when evaluating a CD for potential purchase but it would be helpful if I had a better idea of what kinds of features to be on guard against when I am doing that research. (Feel free to refer me on to another info source on this one, if that would make the most sense.)
Thanks for any help, as always!
Second question: Are there any standard “catches” or pitfalls in the construction of individual CDs that retail investors really need to be watchful for? I know it is important to go right to the filed prospectus document when evaluating a CD for potential purchase but it would be helpful if I had a better idea of what kinds of features to be on guard against when I am doing that research. (Feel free to refer me on to another info source on this one, if that would make the most sense.)
Thanks for any help, as always!
