Convertible Bond
What Is a Convertible Bond?
A convertible bond is a type of corporate bond that gives the bondholder the option to convert the bond into a predetermined number of shares of the issuing company’s stock. Until conversion occurs, the bond functions like a traditional bond by paying regular interest and returning the principal at maturity.
Convertible bonds combine features of both debt and equity investments.
Why It Matters
Convertible bonds can offer investors the stability of fixed-income payments while also providing the opportunity to benefit if the company’s stock price increases. This hybrid structure makes convertible bonds appealing to investors seeking income with potential upside.
Companies may issue convertible bonds because they often carry lower interest rates than traditional corporate bonds.
How Convertible Bonds Work
When investors purchase a convertible bond, they receive periodic interest payments just like a regular bond.
However, the bond also includes a conversion feature, which specifies:
- the number of shares the bond can convert into
- the conversion price
- when conversion is allowed
If the company’s stock rises above the conversion price, investors may choose to convert the bond into shares.
Example
An investor holds a convertible bond that can be converted into 20 shares of company stock. If the stock price rises significantly, converting the bond may produce greater returns.
Convertible Bond vs Corporate Bond
- A convertible bond can be converted into company stock.
- A traditional corporate bond cannot be converted into equity.
FAQs About Convertible Bonds
Why do companies issue convertible bonds?
They may allow companies to borrow at lower interest rates.
Can investors lose money with convertible bonds?
Yes, especially if the company’s financial condition declines.
Do convertible bonds always convert to stock?
No, conversion is typically optional for the investor.
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