Yield Advantage

  

Categories: Bonds, Stocks, Investing

See Convertible Bonds.

Yield advantage here just means that you, the public stock investor, gain an advantage in buying the busted convert bonds of a publicly traded company...at least as far as yield is concerned. That is, you have these busted converts that yield some 6.5%; they convert into the stock that yields 4%, so you have a yield advantage in buying the bonds and just waiting around until eventually, presumably, the common stock price catches up to the convert price...and you can trade in those old bonds for n shares of dividend-yielding stock.

Here, you pick up a 250-basis-point advantage in doing so, while taking bond risk (less) instead of common stock risk.

Wells Fargo was left swimming in these kinds of busted converts after the 2008 loan crisis, and we're guessing Warren scooped up a lot of them. The guy knows how to take advantage.

Related or Semi-related Video

Finance: What are Convertible Bonds?9 Views

00:00

Finance a la shmoop what are convertible bonds? okay there's a joke about the

00:08

Inquisition in here somewhere or maybe something about Cossacks and 17th

00:13

century Russia what do you think animated musical or maybe a King Henry [King Henry VIII appears]

00:17

thing but yeah all that's different kind of conversion way more pedantically a

00:23

company might be having a hard time selling or issuing its bonds to Wall [Man with company briefcase for head meets man with Wall Street briefcase for a head]

00:29

Street in order for them to close the deal with their stock trading today at

00:33

25 bucks a share they might say well these bonds are convertible into 20 [Man with company for a head discussing bonds]

00:38

shares of our stock that is they would have a single thousand dollar unit of

00:43

that bond and it would convert into 20 shares which would then value the shares

00:48

at 50 bucks either thousand divided by 20 there's 50 it's an advanced calculus

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sorry if you didn't have it which would sort of be you know the over/under price

00:56

at which bondholders would start to seriously look at converting their nice

01:01

safe bonds into those risky pesky equities well why would a company offer

01:06

convertible bonds instead of you know just vanilla bonds well if they were [Man discussing convertible bonds]

01:12

stuck paying 6% interest on just bonds but really could only afford to pay 4%

01:18

well they might get the interest rate discount by throwing in that equity

01:23

kicker in the bonds having that convertibility feature yes they would

01:27

suffer dilution at 50 bucks a share but that price is double and change where

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the stocks out here so the company is probably thinking that it wouldn't mind

01:36

some dilution from these bonds being converted up there in stock price right [Arrow points to stock value mark on graph]

01:42

and remember the bonds pay the 4% interest along the way until they are

01:47

converted the moment those bonds are converted into equity well then the debt

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on the balance sheet of the company and its obligation to pay that 4% yearly [Company balance sheet and interest highlighted]

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interest goes mercifully away they print 20 more shares for each bond converted

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and yes those shares may pay a dividend but as far as the convertible bonds go

02:07

they are thereafter converted and saved and remember Jesus Saves but Moses

02:15

invests

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