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Quant Investing: What Happens to Convertible Bonds in 2021?

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Convertible bonds are corporate bonds that can convert into stocks. In the past fifteen years, the annualized rate of return of the convertible bond market was 8.81%, which was only 0.71% less than that of the S&P 500. At the same time, the volatility of convertible bonds decreased by 3.4%. Thus, convertible bonds can also hedge risks while participating in the stock market, which is a good choice for investors.+

In this article, we review the characteristics of convertible bond hybrid securities. Convertible bonds use the conversion price as a critical point to close to the nature of stocks and bonds. When stock prices are low, convertible bonds are used as bonds to protect their value. And when the stock price exceeds the conversion price, the convertible bond can also enjoy profit like an option.

Relationship of Convertible Bond Price with Stock Price

Purchasing convertible bonds is costly for individual investors. Therefore, we introduce convertible bond ETFs such as ICVT and CWB to provide investors to enter the convertible bond market. ETF has the advantages of the low purchase cost and high liquidity for investors. In addition, because of the difference in index selection, ICVT has more technology bonds and speculative-grade bonds. It also makes ICVT more risky and profitable than CWB.

Convertible bonds have outperformed the S&P 500 ETF (SPY) this year, and they have also fallen sharply. Convertible bonds bear much more risks this year than in previous years. We are very curious about the changes in the market this year that make convertible bonds different from last year.

Performance of ICVT, CWB and SPY

Through quantitative analysis, we will explore what happened to the convertible bonds this year. We start from factor analysis and explore possible sources of risk one by one. Then, from different perspectives, we cut out irrelevant reasons through the deletion method. Finally, it summarizes the unknown threat that convertible bonds bear. It is essential to understand the risk that you take when investing.

CY Yang
Quantitative Research Intern, Quantitative FinanceGamma Paradigm

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