For the investor they get the advantage of a steady stream of income due to the payment of a high coupon rate, but will either get back their principle (par value) or a predetermined number of shares in the underlying stock if they are lower.
These are bonds or short-term coupon bearing notes, which are designed to provide an enhanced yield while maintaining certain equity-like risks.
Owners receive full principal back at maturity if the Knock-in Level is not breached (which is typically 70-80% of the initial reference price).
[2] In a low interest rate and high market volatility environment, reverse convertibles are popular as they provide significantly enhanced yield for the investors.
Prior to the turn of the millennium (2000), reverse convertibles mostly consisted of investors shorting standard at-the-money put options.
The barrier protection feature triggered much increased reverse convertible issuances in UK in the early 2000s as well as in the European retail markets.
Reverse convertibles nowadays account for a large portion the structured products issued for retail and private investors.
The issuances of other breeds of reverse convertibles, such as those combining a callable payoff, or a knockout clause, have also increased substantially [4] with the ever changing market conditions.
At maturity, the owner receives either 100% of their original investment or a predetermined number of shares of the underlying stock, in addition to the stated coupon payments.
These instruments are sold by prospectus or offering circular, and prices on these notes are updated intra day to reflect the activity of the underlying equity.