Reverse convertible - Financial definition
Concise definition of the term reverse convertible
A reverse convertible is a type of structured product that offers high coupon payments in exchange for the risk that the investor may receive shares of the underlying asset instead of their principal at maturity if the asset's price falls below a predetermined level. It combines elements of fixed-income securities and equity derivatives.
Comprehensive definition of the term reverse convertible
Reverse convertibles are typically issued by financial institutions and are designed for investors seeking higher yields than traditional bonds. They pay regular, often above-market interest rates during their term. However, the principal repayment depends on the performance of the underlying asset, usually a stock or index.
If the asset's price falls below a certain "knock-in" level during the term or at maturity, the investor may receive the equivalent value in shares rather than cash. This characteristic makes reverse convertibles appealing for investors who are moderately bullish on the underlying asset but willing to accept the risk of potential equity ownership if the asset's price declines. Practical examples include products linked to well-known stocks where the issuer leverages the stock's volatility to offer attractive coupons.
Reverse convertibles are often used by investors to enhance yield in low-interest-rate environments while taking on controlled equity exposure. Market practices typically involve detailed disclosures about the underlying asset, the knock-in level, and the conditions under which the principal repayment will be in shares or cash.