A reverse convertible security or simply “reverse convertible” is a type of structured product which is based on underlying securities (normally stocks). This type of security normally has a fixed term, much like a straight bond.
Typically, reverse convertibles are made up of both a bond which pays a coupon on a regular basis and a put option. The put option allows the reverse convertible security’s issuer to repay principal using underlying assets rather than cash, when the value of underlying assets falls bellow a certain barrier.
As an investor, you benefit from yields earned by redeeming coupons. However the yields are limited to coupon amounts. If the underlying assets perform very well, you still only receive the coupon amount.
On the other hand, if the value of underlying assets decreases significantly, the issuer may exercise the put option and return your principal in the form of low-value or even worthless securities instead of cash.
Although reverse convertible securities often deliver above-average yields and coupons are guaranteed, the potential for loss in the case that securities perform badly makes them a poor choice for investors with low risk capacity.
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