The correct answer is      (B) Two to three years.

Regardless of how long it would take to break-even on the share exchange, converts are best held at least two or three years. The longer timeframe helps offset short-term volatility.

What are Convertibles?
Convertibles are securities that a company issues to raise money, and they can take the form of either bonds or preferred shares. However, unlike ordinary bonds or preferreds, converts come with an added twist: you can exchange them into the company's stock, generally whenever you want.

The "conversion ratio" spells out exactly how many shares you can get for each convert you hold. For instance, Ford Motor 6.5% convertible shares (NYSE: F-PS) are convertible at any time into 2.8249 common shares of Ford (NYSE: F).

You can use this conversion ratio to help decide if it's more profitable to hold the convertible security or the stock. Consider Ford's convertibles. If the stock is currently selling at $8 a share, by converting you would receive the equivalent value of $23 (2.8249 * $8). In contrast, the convertibles might be trading at $38. In other words, they are selling at a conversion premium of 65% ($38/$23).

Another useful tool to measure the feasibility of investing in convertible debt is the amount of time it will take to recoup the initial investment, or the "payback period". So, if Ford's convertible securities yield about 8.6% and the stock currently carries no dividend yield, the convert has an 8.6% yield advantage. If the stock had a dividend, the dividend yield would need to be subtracted from the convertible securities yield. The yield advantage is also known as the marginal benefit or how much extra you earn from the convertible versus the yield, not including capital gains, on the underlying shares. 

If the convert is selling at a 65% premium to Ford's common stock price, its yield enables investors to recoup the extra cost in about 6 years. 

Safe Havens
When the going gets tough, convertible securities are some of the most stable, highest-yielding securities around. They participate in a stock's gains, but are cushioned when the share price turns south. As a rule of thumb, the typical convertible security rises about three-quarters as much as the company's common shares on the way up, but only falls about half as much if the stock goes down. The reason for this is simple, securities pay a fixed income, which limits their downside. But because they're exchangeable into stock, they also are pegged to a firm's underlying share price which makes them less sensitive to interest rate increases.

The Downside?
In the case of bankruptcy, convertible bondholders are considered subordinated to many other forms of debt, which means the other debt must be paid before the convertible bondholders are paid. Like other bonds, convertible bonds are interest rate sensitive and companies are more likely to have call provisions on convertible bonds (it is expensive for companies to convert bonds into common stock after price spikes) in order to take advantage of cheaper debt when interest rates are lowered.

We know that convertible securities can be difficult to understand both mechanically and intuitively, but we also know that their unique characteristics make them important opportunities for income-oriented investors. That's why the latest issue of StreetAuthority's High-Yield Investing newsletter is devoted to the topic. Editor Carla Pasternak waded through the convertible security universe and zeroed in on two convertible securities that offer yields of 8.5% and 11% and are backed by major companies with upbeat long-term outlooks. Carla also showcases a fund that invests in a diverse portfolio of convertible bonds and preferred shares issued by major corporations. To read these in-depth profiles and learn more about the High-Yield Investing newsletter, please visit this link.