Why Do Investors Buy Convertible Securities?

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Why Do Investors Buy Convertible Securities?

Convertible securities are a lot like convertible automobiles. When the weather is sunny and common stock prices are climbing, convertibles can provide more earnings than regular preferred stocks or bonds. On the other hand, when the weather is rainy and common stock prices are falling, convertibles reduce the risk of lowered returns because of their current income stream.

Things To Know

  • Convertibles may enjoy enhanced earnings and reduced risk.
  • Convertibles generally are less volatile than common stock.

Some examples

Imagine that you have invested in convertibles. When the price of a company’s common stock increases by 30 percent, the price of its convertibles may increase by 10 percent or 15 percent. Of course, during this period you also receive either interest (in the case of bonds) or dividends (in the case of preferred stocks).

When the price of a company’s common stock declines by 30 percent, the price of its convertibles likely will also decline but by a lesser amount. And, you also benefit during this period by continuing to receive interest or dividends. Convertibles generally are less volatile than common stock.

On the other side of the coin, convertibles sometimes provide lower earnings. The price of the convertibles may not increase as much as the price of common stocks. In addition, convertible preferred stock may pay lower dividends than regular preferred stock, and convertible bonds may pay less interest than regular bonds.