Saturday, 1 October 2011

Anatomy of a convert - why not cut out the bank and go straight to investors?

As I mentioned in a previous post, there are a number of inefficiencies in a company receiving their money via loans exclusively, and if they are sufficiently large, they'll issue longer dated corporate bonds.  Well, convertible bonds are just another step in the evolution of plain old, or straight bonds.  Understanding the straight bond is about 60% of the job of understanding the convertible, so I'll be spending quite some time on them in the coming posts.

In this posting, I'll just give a brief overview of where I'll be going with the subject.  With straight bonds, the bond buyer hands over cash now to the company, and the company then enters into an agreement with the holder to give him regular payments for usually a fixed period of time.  Often the final payment looks like a 'return of capital' payment.  So what we'll need to do is to understand how to compare cash amounts at different times in the future.  We'll also need to get to grips with the maths of a return or a yield, which is a way of comparing one cash amount with another.  This seems almost too easy to bother with, but there a number of wrinkles it is important to understand.  Once done, we follow with a posting on the so-called yield curve.  A secure understanding of the yield curve represents the core of knowledge you need in the world of fixed income investments.