Chapter 6. Alternative Investments

The search for better-performing assets usually leads investors to explore the broad category of alternative investments, a term generally used to describe investments outside the familiar categories of equities, Treasury bonds, other high-quality investment-grade debt and bank instruments such as certificates of deposit (CDs). This chapter focuses on the most commonly used alternative investments and provides recommendations on which should be considered.

Convertible Bonds: Not Recommended

A convertible bond gives the holder the option—the right, but not the obligation—to exchange a corporate bond for a predetermined number of shares of common stock in the issuing company, creating the perception that an investor can enjoy the best of both worlds. If the stock does well, the holder can convert to equity. If it does poorly, the investor retains the "safety" of the bond and coupon payment. The market recognizes that this option has value: The interest rate on the convertible bond is less than it would be on a similar nonconvertible debt issue.

Here's why convertible bonds are not recommended:

  • As discussed in the fixed income section, bonds rated below AA are not recommended. Most convertibles fall below that level.

  • The bonds of companies below the highest investment grades of AAA and AA actually contain equity-like risks. Equity risks can be obtained more efficiently via common stock ownership.

  • If the stock of a convertible issuer is doing poorly, the ...

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