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February 11, 2013 at 05:31 AM
With the national debt exceeding $16 trillion, the U.S. government has been engaged in a practice called financial repression. The term financial repression was introduced in 1973 and is a technique which helps a country dig out of deep debt. I’ll dispense with its definition and focus on its practical aspects.
First, the problem in the U.S. is rather obvious. If interest rates rise very far, the cost of servicing the public debt would pose a problem. Because of this, Washington has purposely engaged in this practice to maintain artificially low interest rates with the hope that the economy will soon begin to grow at a more normal level. To be precise, the economy has been growing, but this recovery ranks as the second weakest in the post-WWII era. Moreover, with no sign of significant improvement, it’s safe to assume that low interest rates will be here for a while. Obviously, low rates help the government but hurt anyone relying on income from their investments. With this as a backdrop, I’d like to discuss a very good income-generating alternative called a reverse convertible. Here’s how they work.
A reverse convertible is a bond issued by a bank with a period to maturity, an annual interest rate (paid monthly), and a buffer and is sold in $1,000 increments. Moreover, the performance of these instruments is based on the price of an underlying stock. To better understand it, let’s assume the following:
Issuer: Best Bank
Underlying Company: XYZ
Strike Price: $10.00 per share
Buffer: 75%
