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There is also no need to choose to convert before maturity – options always have time value! We can always choose to sell our holding in this hypothetical bond before it matures. The negative yield simply tells us the received return if we waited for maturity and chose not to convert the bond into stock. So long as we believe that it is likely that the underlying stock stays above a level where it makes more sense to convert than to wait for repayment at maturity, that would still be an attractive convertible, even if the level of yield is negative. Looking at the Greeks, if we see that the delta of the convertible remains moderate (say, no more than 0.75) and that gamma of the convertible is still good (above 0.5), we still have a good ratio of reward to risk. If the yield to maturity or put of the convertible has become negative, does that mean that our investment is now going to earn a negative return? Do we need to convert the bond to lock in our gains, which is what the negative yield seems to suggest? It just means that some of the traditional yield measurements for fixed income might not fully reflect the value of that option.Īs an example, we may hold a convertible where the underlying stock price has risen in value by a moderate amount, and we still have a positive view on that underlying stock. Because of that conversion option, the value of the bond if converted into stock can be higher or lower than the par amount of the bond that the issuer must repay at maturity. For example, not all bond investments are held to maturity, especially if an issuer or an investor can force an early repayment of principal through a call or put option.īut for convertible bond investors, there is another difference to consider, and that is because holders have the right to convert a bond into shares of stock. The final return from a bond depends on when they get their principal back from an issuer, and bonds have different features that can impact the timing and value of repayment. In general, bond investors receive coupons with a final repayment of principal. But while having a negative yield is less of a novelty for a convertible bond, let’s look at why this happens, and what the implications may (or may not be) for investors. It used to be that negative yields were uncommon for bonds. Why can convertibles have a negative yield to maturity or put?.
There is some more math involved to get to the precise definition of each measure, but we will try to present a more intuitive view of what each of the Greeks means for investors. Of course, these measures can also be calculated for a portfolio of convertible bonds, as well as for a single holding. The Greeks can therefore be used to help assess both risk as well as potential reward. We follow the practice of using Greek letters to stand for a variable, basically, how sensitive an option, or a convertible bond, would be to those key inputs. Based on this formula, investors can calculate sensitivity analysis to the price of their option. The formula uses only a few inputs but is robust enough to generate consistent and predictable results. In our earlier discussions, we covered how the Black-Scholes option pricing formula revolutionised finance. Don’t worry, we will take it easy on the math, and there won’t be a test! For our final discussion in this series, we hope to demystify the Greek letters that are key to understanding convertibles.