Under what condition will an investor owning a reverse convertible security receive less than their original principal at maturity?

An investor owning a reverse convertible security will receive less than their original principal at maturity when the price of the underlying asset is below the knock-in price. This situation is crucial to understanding the mechanics of reverse convertibles.

Reverse convertibles offer a high coupon payment, but they come with the risk of principal repayment being linked to the performance of an underlying asset, typically a stock. The knock-in price acts as a threshold; if the asset's price falls below this specified level, the investor is effectively forced to accept the underlying asset instead of receiving their full principal investment back. This means they could end up with shares worth significantly less than their original investment, resulting in a loss when the security matures.

In this scenario, if the asset is trading below the knock-in price at maturity, the investor will be compensated not in cash but rather with shares of the declining asset, leading to a total payout that is less than the original principal amount. Understanding the implications of the knock-in price is essential for investors considering reverse convertible securities, as it highlights the risk-reward profile associated with them.