Most economics classes often start an investment unit delving into the two basic instruments for purchasing shares in a company: stocks and bonds. However, the financial integration of the two is often left unexplained and therefore untouched by many familiar with the markets. Simplistically dubbed “hybrid securities,” the combination of both debt and equity into one financial instrument, these securities represent an undervalued opportunity for investors and corporations alike.

The most popular hybrid securities are convertible bonds. The basic convertible bond refers to the issuance of a bond by a company. At the discretion of the bond holder, the basic convertible bond can convert into a predetermined number of shares of the issuing company. The final conversion date and the price per share are both settled at the issuance of the bond, among other variables laid out in the prospectus of the offering. But, like most securities, dealmakers can rework changes into the convertible bond before maturation.

In terms of the details of convertible bonds, laying the technical groundwork for understanding convertible bonds is critical to the discussion. Rooted in complex arithmetic, ordinary convertible bonds can be whittled down to several key elements.

The fixed-income portion of the issuance pays a coupon on a principal, similar to other issuances in the fixed income market. In this way, the debt is sensitive to market fluctuations in interest rate and issuer credit rating. In terms of “conversion into equity,” the conversion price refers to the fixed price per share upon conversion, and the “conversion ratio” refers to the number of shares converted. Parity refers to the equivalency between the value of the convertible bond and value of the company’s common stock.

For the issuer, there are a myriad of benefits in convertible bond offerings. The lower coupon rate allows for the corporation to raise capital at a significantly lower financing rate. Additionally, since convertible bonds are appraised at a fee to its parity, the corporation can raise even more capital per share compared to a regular equity issuance. And, most important component to a corporation’s accounting department, there are additional tax breaks in the issuance of convertible bonds. Interest expenses on a convertible bond are tax-deductible, but fund appreciations and dividends paid by issuance of common stock are non-deductible. As a result, the issuance of a convertible bond is a much more tax-friendly method of accumulating capital for a corporation.

Although the lower yields appear to detract from the appeal to the investor, convertible bonds have many alluring qualities for the investor. For instance, one can consider a stock’s performance in a bear market. The stock will almost positively depreciate in value. If the holder hasn’t converted the convertible bond into stock, then they will be experiencing the downside protection of the fixed payments from the bond, rather than undergoing a loss of income due to loss of stock value. On the other hand, in a bull market, the stock will likely appreciate in value. Conversion of the bond into equity shares will result in the investor’s direct participation in that appreciation in value, which ultimately boosts the investor’s prospects on the upside.

Much has changed in the world of convertible bonds since 1874, when Rome, Watertown and Ogdensburg Railroad offered the first ever convertible bond with a maturity of 30 years and a seven percent coupon to finance the construction of a major train line in the United States.

However, the convertible bond market stands strong to this day. In 2014, electric vehicle designer and manufacturer Tesla Inc. issued its largest fixed-income instrument to the public, worth $920 million with a coupon of 0.25 percent, set to mature on March 1st of this year. With a conversion price set at $360 per share, potential for investors looked very bright in early August, with Tesla’s share prices peaking at $380. Unfortunately for investors, volatility and management controversy have driven that price below $300, indicating that conversion will be unlikely amongst bondholders. In this particular case, Tesla will have to pay $920 million to cover the amount outstanding, a less-than-ideal cut into the company’s $3 billion in cash and equivalents.

As for the current state of the converts market, business has been booming. The U.S. convertible market had a market capitalization of $223.6 billion with 475 issues as of June 30, 2018, as reported by Barclays Convertible Market Watch. According to the Trade Reporting and Compliance Engine, the convertible bonds market averages $11.2 billion in convertibles trading per week, indicating extremely highly liquidity. With rising interest rates in the economy, companies are issuing convertibles at a much higher rate to accumulate capital. And since October, the volatile markets make convertible bonds a very enticing option for investors due to the safety of the fixed income with the embedded equity risk.

Between low financing rates and tax breaks for issuers, a safe gamble for investors, and an unpredictable market, convertible bonds present an excellent opportunity for seasoned buyers looking to bolster the portfolio. In a time where mixed predictions about the market are commonplace, placing funds into both stocks and bonds must be an ideal option. As long as markets continue to function, convertible bonds will bring diamonds in the rough for the smart investor.

Due to high gas prices, consumers have paid more attention to the price per barrel of crude oil, as well as the Islamic communities that are reaping the benefits. The massive amounts of wealth stemming from the high price of oil have tremendously impacted Islamic communities. Places like Dubai and Abu Dhabi have come to epitomize the explosion of available capital within the Middle East. As Islamic communities begin to use their capital to invest with other non‐Islamic communities, principles of Islamic law come into play and issues become much more complicated.

In 2007, estimations reported that the American Islamic community, the Muslims living in the U.S. who govern their investments according to the laws of the Sharia and the Quran, had over $170 billion in purchasing power. This niche in American society has recently become a major player in the world of banking and finance due to this enormous wealth.

While firms are scrambling to access this largely untapped resource, they must first overcome Islamic laws that restrict the usage of their capital. Islamic banking operates with the same intentions as standard Western banking, except for one caveat: finance must follow
the rules set forth by the Quran. Under the
laws of the Quran, Muslims are prohibited
from collecting any form of interest. The
problem this created for the traditional
banking world has led to the introduction
of Islamic banking techniques into the
Western world. The following is an
examination of three techniques used
today to help avoid the zero‐interest‐payments rules of the Quran.

The first of these techniques is called Mudharabah. This technique utilizes the principle of profit sharing. While the lender does not charge interest, they do share in the profits and successes of the entrepreneur, similar to venture capital. The second technique is called Wadiah. With this technique, Islamic banks utilize depositors’ funds at their own discretion, and will often reward the depositor with gifts of cash payments for allowing the bank to use the funds. These cash gifts are similar to interest payments, but are not always guaranteed and do not have a set rate of payment. Recently, there has been some controversy in the Islamic community over the issuance of these Sharia‐compliant Islamic bonds, as some religious scholars question whether these bonds adhere to the religious laws outlined by the Sharia. Consequently, the issuance of Islamic compliant bonds has plummeted recently, falling to $14 billion this year from up to $50 billion last year. The third technique is called Ijarah. This practice essentially rents an asset that corresponds to the principal and interest that conventional Western financing would use. In other words, Ijarah is a sale‐leaseback, where the seller begins leasing the asset back and makes rental payments that correspond to the Western concepts of interest payments.

Islamic banking is still in its infancy and has yet to be fully refined. The vast amount of available capital throughout the Islamic communities has created a niche in the banking world that will continue. Large banking firms and even countries like Japan, England, and Malaysia, are catering to these communities by pledging Islamic‐ compliant‐banking‐services. Banks will certainly not forego the opportunity to enter into this competitive market, as the wealth held by oil‐rich American Islamic communities is a perfect target for Western banks looking to utilize their available capital. Islamic banking should continue to be a major factor in the world economy in the future.