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Hung Convertibles

Definition

“Hung convertibles” is a financial term referring to convertible securities that are close to, but not yet at the point of being profitable to convert into common shares. The term originates from the idea that these instruments are “hanging” in a state of limbo, not quite ready for conversion. They can be seen as a sort of cautious investment, where the investor is waiting for a further rise in the price of the underlying asset before converting.

Phonetic

The phonetics of the keyword “Hung Convertibles” would be: /hʌŋ kɒnvɜrtəbəlz/

Key Takeaways

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  1. Hung Convertibles refer to convertible securities that are near the point of being in-the-money or out-of-the-money, meaning their conversion prices are almost equivalent to the current market price of the underlying assets.
  2. Investors often invest in Hung Convertibles as they offer potential upside through conversion into the underlying stock while also providing regular fixed-income returns like bonds.
  3. One risk that comes with Hung Convertibles is that if the market price of the underlying stocks falls greatly, these securities may lose their value, resulting in a significant loss for the investor.

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Importance

“Hung Convertibles” is a significant term in the realm of business/finance because it refers to a specific condition of convertible bonds, wherein these bonds are ‘hung’ or unable to be converted into stocks because the underlying company stock price has not reached the conversion price mentioned in the terms of the bond. The significance of this term lies in its implications for investors: While these investors are unable to benefit from the potential increase in stock price, they can still take advantage of the bond’s interest payments. Thus, understanding the concept of “hung convertibles” is crucial for effectively strategizing and managing one’s investment portfolio in the context of convertible bonds.

Explanation

A hung convertible is a kind of convertible bond that has not yet been fully converted into common shares because the market price of the underlying stock is lower than the conversion price. Therefore, these bonds remain “hung” as their conversion into common stock is delayed due to unfavorable market conditions. They are essentially employed as a financing tool by corporations looking to raise capital without immediately diluting share value; as such, they offer a way to potentially defer the dilution of shares and provide an alternative to issuing more common stock.In terms of purpose, hung convertibles offer investors an attractive investment option due to their unique structure and the potential for considerable gains. The convertible bond holds a value as a bond, irrespective of the stock price, assuring the holders a certain level of security. At the same time, it offers the possibility of a pay-off if the underlying company’s stock performs well and exceeds the conversion price, making the bondholder eligible to turn their bonds into common stock and potentially sell at a profit. These attributes make hung convertibles a versatile investment instrument, particularly in volatile stock markets.

Examples

Hung Convertibles is a term relating to convertible bonds. These are bonds that can be converted into a specified number of the firm’s common stock shares at the discretion of the bondholder. If a bondholder chooses not to convert the bond into equity due to unfavorable market conditions, the bond is referred to as a “hung convertible”.However, it can be challenging to provide specific real-world examples of hung convertibles due to the fact that the decision to convert or not is largely dependent on market conditions and the discretion of the bondholder. As such, companies generally do not publicly disclose specific instances where their convertible bonds have become hung convertibles.But to provide you with a sense of the kind of situation where one might encounter hung convertibles, let’s consider three hypothetical situations:1) **Tech Corp Convertible Bond Issue**: Tech Corp, a technology company, decides to issue convertible bonds, carrying an attractive coupon rate to raise funds for expansion. The company’s stock were trading high at the time of bond issuance. However, soon after, market conditions turn unfavorable and the company’s stock price drops significantly. Bondholders, who initially might have planned to convert bonds into shares, are now forced to hold onto the bonds because conversion to shares would result in a loss. In this case, these bonds have become hung convertibles.2) **Green Energy Startup**: A green energy startup, Green Light, issues convertible bonds to fund research and development. Initially, the company does well, and the stock value is growing. Suddenly, there are regulatory changes that put strain on their business model causing the stock value to plummet. The bondholders, aware of the falling stock value, would prefer to hold onto the bonds instead of converting them, leading to hung convertibles.3) **Pharma Inc’s New Drug Launch**: Consider a pharmaceutical company, Pharma Inc., issues convertible bonds to fund the launch of a highly anticipated new drug. However, the drug fails in the last phase of clinical trials leading to a significant fall in the company’s share price. The bondholders would then hesitate to convert their bonds into equity shares, making these bonds hung convertibles.

Frequently Asked Questions(FAQ)

What are Hung Convertibles?

Hung Convertibles refer to convertible securities with share prices that have fallen significantly below the conversion price. Therefore, the value comes from the yield of the bond rather than the potential equity upside.

What does the term ‘hung’ in ‘Hung Convertibles’ signify?

The term ‘hung’ signifies that these convertibles are ‘stuck’ or ‘hung up’ on their bond value, as the potential equity benefit from conversion has diminished due to the drop in share price.

When would an investor buy a Hung Convertible?

An investor might buy a Hung Convertible if they believe that the underlying company’s stock price will rebound, or for the higher yields that these securities typically offer compared to regular bonds from the same issuer.

How does conversion work with Hung Convertibles?

Just like any convertible securities, Hung Convertibles can still be converted into equity shares, but the conversion at this point is not financially beneficial, as the share price is lower than the conversion price.

Can the status of Hung Convertibles change?

Yes. If the issuing company’s stock performance improves and the share price rises above the conversion price, these securities will no longer be considered Hung Convertibles.

What is the difference between a Convertible and a Hung Convertible?

The key difference is the stock price relative to the conversion price. Convertibles offer potential upside through equity if the stock price moves above the conversion price, whereas with Hung Convertibles, the stock price has significantly dropped below the conversion price.

Are Hung Convertibles a high-risk investment?

Like all investments, Hung Convertibles come with risks. Hung Convertibles can be riskier than regular convertibles because they depend more on the issuing company’s ability to improve its stock price or on its creditworthiness to make coupon payments. It is thus crucial to assess the issuer’s overall financial health before investing.

Related Finance Terms

  • Convertible Securities: Securities, usually bonds or preferred shares, that can be converted into a different form, typically into the common stock of the company.
  • Equity-linked Securities: Financial instruments whose value is linked to the price movements of an equity. Hung convertibles fall under this broad category.
  • Strike Price: Also referred to as the conversion price, it is the price at which the holder of the convertibles can convert their securities into common stock.
  • Dilution: A reduction in the ownership percentage of a company, or shares of stock, due to the issuance of new equity. Dilution can occur when holders of convertible securities decide to convert their holdings into stock.
  • Conversion Ratio: The number of common shares received at the time of conversion for each convertible security.

Sources for More Information

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