The Handbook of Hybrid Securities: Convertible Bonds, CoCo Bonds and Bail-In

2 Convertible Bonds

Convertible bonds have been around more than a century and their origin can be linked to the history of the American rail roads. The railroad magnate J.J. Hill needed, in 1881, an innovative way to finance one of his new projects. The convertible bond market has evolved enormously since this first issue more than a century ago, but the principle of mixing debt and equity in one single instrument remains the same. This chapter provides an overview of the different kinds of convertible bonds, some specific instrument features, and an introduction to the terminology used.¹

2.1 INTRODUCTION

Table 2.1 contains an overview of the outstanding convertible bonds as of May 1, 2012. This table illustrates the importance of the US convertible bond market both in size and number of convertible bonds issued. The convertible bond market is significantly smaller than the corporate bond market. The $492 bn outstanding convertible bonds display, however, a wider variety of different features. Each of these features has an impact on the valuation and price dynamics of the convertible bond. Layers of complexity are combined and stacked upon each other. This lack of standardization is an important challenge for a newcomer to the convertible bond scene. The job of a convertible bond analyst does not start with the selection of a suitable pricing model. Instead, the first step is always a thorough reading of the prospectus where all the specific characteristics are described at ...