What are Hung Convertibles?
The Hung convertibles are convertible securities whose share price of the underlying asset is much lower than the conversion price, which makes conversion of the securities into ordinary shares unlikely.
Key points to remember
- The Hung convertibles are convertible securities whose share price of the underlying asset is much lower than the conversion price, which makes conversion of the securities into ordinary shares unlikely.
- Due to their limited conversion prospects, suspended convertibles, also called exploded convertibles, are traded more like debt instruments.
- To solve the problem of a suspended convertible, a company should improve its fundamentals to boost the common stock high enough to reach the conversion price.
Understanding Hung convertible
Due to their limited conversion prospects, suspended convertibles, also called exploded convertibles, are traded more like debt securities than quasi-equities. Hung convertibles also refer to two other cases where the probability of conversion is low:
- If the issuer is unable to force the conversion until the underlying common shares reach a predefined price level.
- Because the date of the call is still far away.
Hungarian convertibles can take the form of bonds, guaranteed by guarantees, or debentures, which depend on the promise of the issuer to pay its bonds. For example, consider a convertible debenture with a face value of $ 1,000 which can be converted into 100 shares, for a conversion price of $ 10. If the price of the underlying stock is $ 4, this debenture would be considered a suspended convertible, especially if it matures in a relatively short period. Such debenture would be evaluated as a debt instrument, the price is determined by several factors, including the interest rate, maturity, interest rates and current market yields and the credit rating of transmitter.
The valuation of the convertible is a complex exercise, because the factors that impact on bonds, such as interest rates, and the factors that impact on equities, as earnings growth should be analyzed tandem. According Calamos, the price of a convertible operation closer to its investment value, or the value of an equivalent non-convertible bond will be more influenced by the interest rate that a nearest operation of its conversion value . In general, however, a change in the fundamentals of the issuing company, for better or for worse, will have the greatest impact on the price of a convertible.
To solve the problem of a suspended convertible, a company should improve its fundamentals such as revenue growth, operating margins and return on invested capital to boost high enough shares to reach the conversion price .
Advantages and limitations of Hung convertible
Some investors see suspended convertible securities as the best of both worlds. They have the qualities of income and stable price of a bond, the higher the conversion function that can offer the potential to gain shares, which have historically provided greater capital appreciation and were less sensitive to rate interest than bonds. In other words, an investor is paid to wait by earning coupons until maturity or conversion into common shares. For an investor in shares, convertible can offer some degree of participation in rising markets and better protection against declines in turbulent markets that hold common shares directly.
Hung convertibles also have drawbacks. Due to the conversion function, convertibles pay lower coupon rates than bonds of the same maturity and credit quality. Convertible investment manager Calamos Investments establishes this difference between 300 and 400 basis points, which represents a considerable gap in today’s low interest rate environment. And if the issuer’s action behaves badly, the investor will be left with a less well-paid bond.