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Convertible bonds: Is this love, or a teenage crush?

The US primary convertible bond market has grown rapidly this year, providing low-cost funding to highly rated corporates at a time when other sources of capital are running dry. The market's proponents claim convertibles have matured into a mainstream financing instrument. But the high degree of structuring suggests that many deals this year have been pure volatility plays sold to a new breed of hedge fund investors that might withdraw as quickly as they appeared.

The huge increase in convertible bond issuance in the US this year has been heralded as evidence that the market is finally coming of age. Certainly the figures look impressive. By June 2001, 111 deals worth $56 billion had been issued in the US alone, according to data provided by, a convertible bonds news and data website owned by Morgan Stanley. The figure means that the market is responsible for more than half of all types of equity issuance.

That isn't so surprising given the dire state of common-stock issuance this year, but $56 billion is just $5 billion short of US convertible issuance for the whole of last year. What's more, most of the deals have been done for investment-grade corporates, which historically in the US have shunned the converts market in favour of straight debt or equity issuance. It's traditionally high-yield companies that tap the US converts market. (The opposite is the case in Europe.) "This year's issues have been dominated by much more solid, stable companies with larger balance sheets, liquid stock and investment-grade ratings," says Philip Jones, global head of equity product development and equity-linked capital markets at Merrill Lynch.

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