Equity-linked bonds are securities designed for risk-conscious investors who seek above-average interest payments in markets that are rising slightly or moving sideways, and who are willing to assume equity risk in return. The potential returns are limited to the coupon.
How do equity-linked bonds work?
Equity-linked bonds are tied to stocks or indices and are therefore linked to the price performance of the underlying asset. Like bonds, they pay a coupon, which, however, is significantly higher than that of a comparable bond. In return, the risk is also higher than with regular bonds. This is because at maturity, the investor is either repaid the face value in cash or, if the stock is trading below the agreed-upon strike price, is repaid with a predetermined number of shares (known as “cash or share”). In this case, the investor then decides whether to hold onto the shares or sell them. The interest (coupon) is paid out by the issuer in either case.
What to keep in mind
Anyone who decides to invest in a reverse convertible should be confident in the stability of the underlying stock. This is because the reverse convertible depends on the performance of the underlying asset. While the interest payment on the face value does not depend on the stock’s price movement, the repayment does. If the stock is trading below the strike price, the face value is not repaid; instead, the stock is delivered at the strike price. At the time of delivery, the stock is worth less. The investor can then decide for themselves whether to realize the loss – that is, sell the delivered shares at the lower price – or whether to hold onto them in their portfolio, believing the stock will rise again.
