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Definition: Reverse Convertible Bond
Reverse Convertible Bond is a complex investment vehicle. As the name suggests it’s a type of short term convertible bond which generally has a maturity within a span of 2 to 3 years. Reverse Convertible Bond, also termed as RCB consists of two components,
First is a debt instrument which gives the value of a coupon which is more than the market in general,
And second one is a derivative, RCB has a put option, which means the bond issuer can pay the amount to the investor in the form of shares rather than cash, if the price of the shares has gone down to a predetermined price.
Also it is not necessary that the shares of the company which is given by the bond issuer should be related to its business. It can be of any industry. The major difference between a convertible bond and reverse convertible bond is that, in the former case, call option is used, which means that the bondholders have the right to convert their bonds into debt or equity whereas in latter case, put option is used which means that the issuers have the right to convert the bond into debt or equity. Reverse Convertible Bonds are generally used because they provide higher yields in short term. This can be said because at maturity, in addition to the coupon payments, the owner of the RCB gets either the entire principal amount or the shares of a company (at the discretion of Bond issuer).