Convertible Bonds (Demystified)

CONTENTS

INTRODUCTION

1 CHAPTER

2 CHAPTER

3 CHAPTER

4 CHAPTER

5 CHAPTER

6 CHAPTER

ADDENDUM #1

ADDENDUM #2

ADDENDUM #3

ADDENDUM # 4

ADDENDUM # 5

ADDENDUM #6

ADDENDUM #7

ADDENDUM #8

INTRODUCTION

This book has evolved from my thirty-two year experience as an Investment Advisor.

For the last twenty (20) years of practical day-to-day investment, I have managed my client’s portfolios using exclusively my Convertible bond investment program and the Sheridan Market-neutral hedge investment program

This book is designed to introduce you, the investor, to the wonderful world of Convertible bonds, whether you are a layperson or a professional.

In this book, we will:

Demystify Convertible bonds

Convertible bonds provide excellent total returns, and are suitable for all investors. They are rarely recommended by professionals in the investment community because those investment professionals haven’t spent the time and effort needed to learn the subject.

Believe it or not, there are only five ( 5 ) major terms that we need to understand in order to be able to invest safely and profitably in Convertible bonds.

Convertible bonds are

THE BEST OF BOTH WORLDS

The world of debt (bonds)

The world of equity (common shares)

We will discover that Convertible bonds have:

Full downside protection in bear markets due to the investment value, the floor under which the Convertible bond should not trade.

Unlimited appreciation potential in bull markets due to the conversion value.

Find all about the (SECRET) of Convertible bonds

The more buy and sell decisions that we make, the more costly mistakes we are liable to make. We usually buy on the sell offer and sell on the buy offer , the cost of this spread between the buy offer and the sell offer added to the buy and sell commissions can become very costly indeed.

NO MORE

"Investments in Convertible bonds should last an average of two years (2) to five years (5).

After having made the original buy decision and pay the buy commission, we will    not have to make the decision to sell and pay the sell commission before two years (2) to five years (5). This is quite a saving compare to those who trades often.

When the company recalls their Convertible bonds, there are no commission charges (eliminating the sell commission).

There are two ways to make money. One way is, as we all know, to accumulate revenues. Another way is to reduce our investment expenses. With the Convertible bond program we will use both of these methods to increase our capital. We will do that whether we are in a bear market or in a bull market

THE SECRET IS:

A Convertible bond will automatically act as a debt investment in a Bear market and act as an equity investment in a Bull market. This switching is done through the internal mechanism of the Convertible bond and does not require any decision making or any transactions on our part.

Just imagine, sitting in our favorite armchair and watching our investment automatically switching from a debt investment to an equity investment without having to lift a finger, this will happen automatically. The accuracy of this switching mechanism will always beat most signals given by financial analysts. You will never have to time the market again.

Convertible bond investment program.

We will use a step-by-step procedure, analyzing a twenty year (20) proven Convertible bond investment program. By the end of the program, we will pride ourselves in being able to manage our own portfolio. This means, never having to rely on anybody’s recommendations anymore, independence at last.

Returns for this Convertible bond investment program should be fifteen percent ( 15% ) minimum return per year on a cash investment basis.

The Convertible bond world

Before investing in Convertible bonds, we should verify that there is a market large enough and diversified enough for us to have a good selection.

We will look over a list of 468 Convertible bonds in some eighty-one industries (81). With each one of those Convertible bonds, we will analyze thirteen (13) Columns of data.

Sheridan Market-neutral hedge investment program

We will also look at the Sheridan Market-neutral hedge investment program. In this program we will use Convertible bonds for the long side of the program and the company’s common shares for the short side of the program.

This program was set–up in 1989. Average returns for this program has historically been 25% to 30% per year on a cash investment basis .

Let us now discover Convertible bonds and the joy of taking our first step in our journey toward peace of mind and INDEPENDENCE.

1 CHAPTER

THE MARKET

This book is aimed at professional investors, serious investors and the educated public.

In this book, we will learn everything there is to learn about Convertible bonds and our two investment programs, the Convertible bond investment program, and the Sheridan Market-neutral hedge investment program.

The main reason for this book is primarily to learn about Convertible bonds. Convertible bonds have been in existence for over one hundred years. Using a good investment program to invest in Convertible bonds means that Convertible bonds are about the safest investment possible. A Convertible bond is a hybrid investment, containing both equity investment and debt investment.

Most investors that bought this book already have a good knowledge about investing. Nevertheless, let us have a short review of what we mean by THE MARKET.

THE MARKET is divided into two major parts, the Stock market (equity investing) and the Bond market (debt investing).

All major economic and financial changes in the world will be reflected in The Market.

DIFFERENCE BETWEEN

   BONDS (DEBT)

   AND COMMON SHARES (EQUITY)

COMMON SHARES: Buying common shares of a company is buying a part of that company. When we buy common shares of a company we become a part owner of that company.

As a part owner of that company we participate in the gains and losses of that company.

BONDS: Buying bonds of a company is lending money to that company. When a company issues a bond, they also have to provide a prospectus.

A prospectus is a document that states the conditions that are attached to that loan. Among the conditions attached to that new bond issue, the Company has to describe the interest that they will pay, called (the coupon) and the date at which they will repay the loan, called (the maturity date).

The prospectus contains all the information that we need to know about that issue. It is a very good idea to obtain a copy of the prospectus from the issuing company. (The prospectuses are free).

It is also very interesting to recognize that the majority of us have always invested in the equity portion or the debt portion of the market, but rarely in both. Stockbrokers usually specialize in the equity market or in the bond market. They are very seldom knowledgeable in both markets.

DO WE REALLY UNDERSTAND THE STOCK MARKET?

Whenever someone learns that I obtained my Stockbroker’s license in 1977 and that I toiled in the investment industry ever since, two things usually happens.

FIRST, A STATEMENT:

Stock Market investing is so complicated that I do not understand anything about it.

I have some money invested, but I do not know in what type of investment.

SECOND, A QUESTION:

Where should I invest my money today

It has never ceased to astonished and to saddened me to see a person that has worked maybe 20 or 25 years or more to accumulate a certain amount of money or has worked very hard to build a business, having to go and trust a complete stranger in the hope of being able to collect an uncertain amount of return on his investment.

We have been clever enough to work almost a lifetime and/or build a business to amass a certain amount of money. We have proven ourselves; surely managing our portfolio should be a cinch.

In this book, we will prove that we can do it.

WE WILL BECOME IN FULL CONTROL OF OUR INVESTMENTS.

Never again will we have to trust Stockbrokers, Analysts, Financial reporters, or even economic news issued by the Government.

WHO ARE WE?

The answer is very simple; we are INVESTORS, not analysts.

Being investors, we will use reliable sources of information to supply us the data required for us to be able to choose and invest intelligently.

WHAT DOES THE WORD INVEST MEANS?

The Cambridge dictionary online, defines the word Invest, as

To put money, effort, time etc. into something to make a profit or get an advantage.

Notice the wording which says to put:

Money:   Investors, speculators and gamblers all put money.

Effort  We will engineer a blueprint of the economy and the investment world to minimize our efforts.

Time   In the chapter called The Convertible bond program, The investment we will look at how to set-up an investment portfolio. The way this portfolio will be set-up will take us only a few minutes per day to follow all our investments.

What we need is to keep everything as simple as possible

KEEPING TRACK OF THE STOCK MARKET

There is a humongous difference between keeping track of the stock market and trying to predict the future direction of the stock market.

Among the thousands predictions that are published daily by financial analysts, Stockbrokers, Financial journalists, not forgetting all levels of government, maybe a few predictions might come to pass. Even most of those few predictions probably are lucky guesses from the issuers. It might not be as bad as it looks; predictions nevertheless are dicey propositions.

It is almost impossible to predict the direction of the financial sector, the economy, and the Stock market. We also have to realize that the whole world today is interconnected; it makes predictions even more difficult.

A major bank failure overnight in Japan might very well throw the Dow Jones Industrial Average in a tailspin upon the opening of the market. Part of that money would have been invested in the US economy. The lost of investment will result in a slower economy and a lower Stock market.

A major mineral find in Asia on the other hand might hit the price of that mineral very hard. The price of minerals is quoted in US Dollars. The lower mineral price will help the Economy, thus create a rise in the Stock market.

We do not really need to know what caused an increase or a decrease in the Stock market. The change of direction happens automatically. We only need to know the general direction of the Stock market.

T H E M A R K E T

The market is composed mainly of two parts. The first part is the Bond market also called the Debt market. The second part is the Stock market also called the Equity market, this is the part that people are the most familiar with.

Let us analyze and simplify those two parts.

PART 1 DEBT INVESTMENT    (Bonds)

Buying a bond is exactly the reverse of borrowing money from a bank.

When you borrow money from a bank, you enter into a contract with that bank to borrow a specific amount of money, for a specific time and at a specific interest rate. In that contract, the bank will state the rate of interest (rent) that they will charge. They will also state the amount of interest to be repaid and the time at which it is to be repaid. Also stated, will be the time at which you will have to reimburse the amount borrowed.

When you buy a bond, you are the bank since it is you that is lending the money. Just like the bank you lend the money to an organization for a specific time, called the maturity date. Just like

the bank you will charge rent on that money, called the coupon. The organization has to issue a prospectus (contract) in which it states the conditions of the lending. Among those conditions, we will find the coupon rate (interest rate) the mode of interest payments (usually every 6 months) and the date at which they will have to reimburse the loan, the (maturity date).

FACTORS AFFECTING A BOND:

We could buy a bond from a Company on the issue date at 1,000$ and return it to the Company on the maturity date at 1,000$. We would be collecting our interest but would not participate in any capital gain since we have lent money to the Company but have not bought shares of the company. During the life of the bond, we would receive the interest rate quoted on the bond. (Interest is usually paid every 6 months)

Between those two dates the price of the bond will vary in the opposite direction of the interest rate. Interest rate increases, price of bonds decreases.

The main factors affecting the bond price are inflation and interest rate.

INFLATION:

A simple definition for the word inflation could be an increase in the price you pay for an item or a decline in the purchasing power of money.

Inflation is caused by too much money in circulation. A lot of that money is borrowed