Reverse convertible

A reverse convertible is a bond that can be exchanged for shares at the option of the issuer. This contrasts with a convertible bond that can be exchanged for shares at the option of the holder. A convertible give the holder an embedded call option, whereas a reverse convertible give the issuer a put option.

Reverse convertibles usually offer high rates of interest, but the potential upside is limited to the interest. The best possible outcome (for the holder) is getting both the interest and the principal. However the downside is far greater: if the share price falls, then the issuer will issue repay the principal in shares. As the number of shares is calculated at a rate fixed when the reverse convertible is issued (i.e. the put has a fixed exercise price), the potential loss is is large as the possible fall in the share price.

In other words, the risks of reverse convertibles are the risk of holding equities, whereas the potential gain is limited.

Convertibles exist for a reason. They resolve an agency issue. What similarly useful function reverse convertibles perform is not clear, although they clearly do appeal to some investors.