This excerpt comes from an article titled "Bartlett Likes Convertibles" in the October 7, 1991, issue of BondWeek, p

Question

7:
"Bartlett & Co is selectively looking for opportunities in convertible bonds that are trading cheaply because the equity of the issuer has dropped in value, according to Dale Rabiner, director of fixed income at the $800 million Cincinnati-based fund. Rabiner said he looks for five-year convertibles trading at yields comparable to straight bonds of companies he believes will rebound."
Discuss this strategy for investing in convertible bonds.

Answer 1

As discussed below the strategy offers upside potential but has more inherent risk.

Typically, convertible bonds pay interest that is less than nonconvertible bond. This is because nonconvertible bonds don't have the conversion privilege found in convertible bonds. Rabiner wants to buy convertible bonds that pay a rate of return similar to nonconvertible bonds. Rabiner may be able to achieve this if it is true convertible bonds are selling at a steep enough discount.

For example, a nonconvertible bond selling at 100 and paying a 10% coupon payment gives
a per dollar rate of return that is equivalent to a convertible bond selling at 80 and paying an 8% coupon payment. For example, each pays 10 cents on the dollar. Besides paying the same rate of return, the convertible bond has a conversion option so that it shares in upside potential whereas a nonconvertible bond does not. However, nonconvertible bonds typically have prior claims if firms default. Thus, in this case, buying convertible bonds offers a greater potential return but is also a more risky strategy.