Barbara Kendall

Barbara Kendall

By BARBARA KENDALL

Q. Barbara asks: Dan, I'd like to get my head around some of the other listed products in the sharemarket table. What are convertible notes and warrants?

A. Dan Dividend responds: There are a handful of listed convertible notes and warrants, as a glance at the newspaper sharemarket table reveals. Let's start with some quick definitions.

Convertible notes

Convertible notes spend the first years of their lives as debt securities, paying a set rate of interest at regular intervals. However, on the maturity date things get interesting: the notes convert, usually one for one, to ordinary shares. One of my favourite investing websites, Investopedia.com, calls convertible notes the chameleons of the investment world!

It's a contrast to garden-variety debt securities that simply expire on the maturity date, with the investor receiving their money back.

There is an important distinction between mandatory convertible notes, which always convert to shares; and optional convertible notes, where the holders can choose between converting or getting their money back.

Convertible notes are usually issued at a price similar to the price of the company's shares at the time of issue. Conversion normally doesn't require payment - the notes are simply exchanged for shares.

Warrants

Listed company-issued warrants have the same characteristics as, but shouldn't be confused with, the options that trade in the derivatives market. We'll cover these in a later article.

Share options and warrants give you the right to buy shares on a set date at a pre-determined price (the exercise price). If the share price goes up, you can exercise your options or warrants to pick up shares at a discount and you're away laughing.

If the share price falls, you can let your options or warrants lapse as they carry no obligation to buy shares.

Gavin Kennedy from NZX firm Forsyth Barr will explain the features and benefits of convertible notes and warrants.

Gavin says: Convertible notes give you the opportunity to own equity in the company later, through buying an interest-paying security now. They may be attractive to people who want regular income with the potential bonus of capital gain if the shares do well over the note's life.

Holders typically receive a slightly lower rate of interest than holders of equivalent debt securities. This is because they get the benefit of owning shares later.