A study of the suitability of convertible bonds for commercial bank investment portfolios

Includes bibliographical references (pages 81-83)The purpose of this thesis is to examine the suitability of convertible bonds as an investment medium for commercial banks. Convertible bonds are the only group of securities eligible for purchase by commercial banks which offer the possibility of substantial price appreciation through participation in the growth of corporate earnings. Yet, because convertible bonds appear to be more complex than other bank eligible securities, there has been little interest in them for bank investment portfolios. A natural consequence of this has been unfamiliarity with their characteristics and unique advantages and a tendency to eliminate the group from consideration by classifying it as speculative. An attempt was made in this study to explain the distinctive characteristics of convertible bonds. This included discussions on why companies issue them, investment regulations and restrictions, ratings and quality, investment and conversion values, and premiums. The regulations that apply to their purchase by commercial banks must be considered with the distinctive characteristics. They, too, are unique in that they are more restrictive than the regulations that apply to other bank eligible investments since convertible bonds are the only group for which there are any limitations on purchase price. Convertible bonds have both advantages and disadvantages from a commercial bank viewpoint. The principal disadvantages are; possible substantial price appreciation through an increase in corporate earnings which a bank can legally receive in no other investment, their ability to stabilize portfolio market value since their market price will often rise when other bond prices are declining, and their relatively good marketability due to their wide ownership and the activity of arbitragers. A two-year study of the price behavior, in a declining bond market, of convertible bonds compared with other bank eligible securities, U.S. Governments, municipals, and non-convertible corporates, showed that convertible bonds increased more in price and fell less in price than the other securities for the two-year period. However, convertible bonds did have much wider price fluctuations in interim periods. The conclusion of this study is that although not all convertible bonds are suitable or desirable for commercial bank investment accounts, opportunities to purchase better grade issues should not be ignored by commercial banks that understand the characteristics and peculiarities of the group and of individual issues. The bank must be willing to assume some risk, both of loss and of criticism, in order to secure the unique advantages of convertible bonds which can be great in relation to that risk.M.S. (Master of Science