Zero-Coupon Convertible
Candlefocus EditorThese bonds offer a unique advantage to investors, as the zero-coupon bonds are considered debt securities. In the event of bankruptcy, bondholders will often be repaid ahead of shareholders, providing more security for investors. Both the zero-coupon and the convertible features of zero-coupon convertibles create balanced risk/reward profiles for investors.
Additionally, zero-coupon convertibles offer investors a unique tax advantage. Specifically, because the bonds are initially sold at a significant discount, the taxes on any currency gains at maturity are deferred until the maturity date, when the bonds will be redeemable for their face value. This deferral can create considerable savings for bonds held to maturity, as the tax rate at maturity will likely be lower than the taxes paid on the original discounted purchase.
Despite these benefits, zero-coupon convertibles can be challenging to price accurately. The zero-coupon feature, income deferral characteristics, and risk of conversion all require sophisticated pricing models to factor in. Consequently, investors need to do thorough research before investing in zero-coupon convertible bonds.
In short, zero-coupon convertibles are a unique debt instrument that offer investors the potential of attractive returns in the form of equity conversion upside, a tax deferral advantage, and increased safety in the event of bankruptcy. By properly pricing and monitoring zero-coupon convertibles, investors can generate attractive returns while maintaining reasonable risk profiles.