- 1). Select high-quality bonds from the universe of convertible bonds available for investment. High-quality bonds must be A-grade rated by credit rating agencies such as Moody's, Standard & Poor's and Fitch. You can get a list of convertible bonds from a finance website such as Yahoo! Finance, MSN Money or The Wall Street Journal.
- 2). Subtract the yield offered on the convertible bonds from the yield offered on the non-convertible bonds of the same company.
- 3). Use the bond contract to determine the price at which the bond can be converted by investors. For example, a bond contract may list that the bond with a face value of $1,000 can be converted to 20 shares of the company. This implies a price of $50 per share.
- 4). Obtain the current market value of the company shares; again using one of the finance websites. For example, suppose the current market price for the stock is $40.
- 5). Subtract the conversion price from the market price of the stock to obtain the amount by which the stock price will have to increase for the conversion to be profitable.
- 6). List the difference in yields alongside the differences in prices that will result in a profit.
- 7). Compare the differences and using your expectations of stock price changes. For example, suppose the stock has a yield difference of 3 percent, and you believe there is very low probability that the stock price will increase by $10 in the next year. Clearly, this convertible bond does not offer much benefit to an investor.
- 8). Select the convertible bond that offers a low yield difference and a low price difference. It is rare for a convertible bond with the lowest yield to have the lowest price difference, so as an investor you need to incorporate your expectations during the selection process. A low yield difference helps you retain the benefits from the fixed-income bond and a low price difference increases the chances of making a profit from conversion of the bond in the near future.
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