What Is a Revertible Bond?

A revertible bond is a unique type of convertible corporate bond. It is also known as a reverse convertible bond, which automatically converts into shares of the company's stock if the underlying stock drops below the conversion price. Usually, these bonds have an expiration date or time limit. If the bond reaches the expiration date, it will either convert into a stock or revert to a bond permanently.

Revertible bonds are usually offered by risky companies that are not considered investment-grade. These companies tend to provide very high interest rates on revertible bonds. However, stable companies find it challenging to offer these bonds because owning one of their corporate bonds carries virtually no risk, and share prices are not expected to fall.

Basics

In financial instruments, a unique investment option exists, going by the names of a reverse convertible bond or, simply, "revertible." This instrument is categorized as a convertible bond but possesses a distinctive mechanism. When the issuing company's stock undergoes a decline, falling beneath a predefined price threshold, this bond undergoes automatic conversion into the company's common stock.

Revertible Bonds: A Dynamic Investment

Revertible bonds, a distinctive breed among corporate bonds, automatically transmute into company stock when the underlying stock's value dips below the conversion threshold. These bonds carry a predefined expiration date, at which juncture they either convert into stock or remain as bonds indefinitely. Typically, revertible bonds are affiliated with high interest rates and are extended by corporations categorized as high-risk and not investment-grade.

Contrary to conventional convertible bonds, where bondholders can convert into company shares but are not obligated to, revertible bonds function differently. In the case of revertible bonds, a specific trigger price prompts automatic conversion, signaling a perception of reduced corporate stability in the market. Under such circumstances, owning company shares may prove wiser than holding company-issued bonds, as stock liquidity surpasses bond liquidity.

Nonetheless, in times of company asset liquidation, bondholders are accorded priority over common stockholders. This situation may incentivize investors to hold failing company assets in the form of bonds rather than stock shares.

Revertible Bonds: High Risk, High Reward

Revertible bonds offer attractive interest rates, primarily due to their potential for conversion into company shares, which can yield higher returns but come with increased volatility. This dynamic suits companies with elevated risk profiles, lacking investment-grade status, as they already carry inherent risk, justifying the higher bond returns.

For more stable enterprises, the feasibility of offering revertible bonds is limited. Their stock prices tend to remain steady, making the bond-stock choice one-sided, favoring the safer corporate bonds over the stocks. Consequently, revertible bonds are an impractical option for large, established companies.

Conclusion

Revertible bonds represent a unique category of convertible corporate bonds, often recognized as reverse convertible bonds. These financial instruments automatically convert into the company's stock when the underlying stock value falls below a predefined threshold, typically accompanied by an expiration date. Such bonds are typically associated with companies considered high-risk and non-investment grade, offering enticingly high interest rates. However, stable companies seldom opt for revertible bonds due to the one-sided risk-reward ratio, as their stock prices tend to remain steady. Thus, revertible bonds are a practical choice for high-risk ventures but less feasible for well-established, stable companies.