Investors owning convertible corporate bonds in Spanish companies are throwing their arms above their heads. And not for naught. The nature of these shares is intrinsically risky and, although they have rebounded slightly in the past few days, prices have dropped by nearly half since they products were issued. Extreme volatility is one of the main hazards of convertibles.
So why are bond prices tied so closely to stock market action? Because the price at which a company exchanges bonds for shares is normally agreed on in advance. That is to say, if at the time for converting shares the market value is lower than the fixed price, the bondholder takes a hit considering that for the price invested he could buy more shares on the open market. That said, the inverse can occur when markets are flush.
Tic, tock, tick tock?
There is some time to overcome the current market conditions. But if an investor were to cash in his bond now, he would do so at a loss. Those who bought convertible corporate bonds from Santander would lose the most. The Spanish lender has dropped 63% since October of 2007, when convertibles worth 16.04 euros were issued. On Friday Santander's stock price closed at 5.93 euros per share.
Bondholders with obligatory convertibles from other firms within the banking sector could also receive shares at a higher rate or, similarly, will have a right to fewer shares.
