What is a convertible bond?
A convertible bond is a type of bond that can be converted into shares of stock in the issuing company. Convertible bonds are usually issued by companies that are looking to raise capital, and they offer investors the opportunity to convert their bonds into shares of stock at a later date.
a bond that can be exchanged for ordinary shares
In finance, a convertible bond or convertible note or convertible debt (or a convertible debenture if it has a maturity of greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features. It originated in the mid-19th century, and was used by early speculators such as Jacob Little and Daniel Drew to counter market cornering.
Convertible bonds are most often issued by companies with a low credit rating and high growth potential. Convertible bonds are also considered debt security because the companies agree to give fixed or floating interest rate as they do in common bonds for the funds of investor. To compensate for having additional value through the option to convert the bond to stock, a convertible bond typically has a coupon rate lower than that of similar, non-convertible debt. The investor receives the potential upside of conversion into equity while protecting downside with cash flow from the coupon payments and the return of principal upon maturity. These properties—and the fact that convertible bonds trade often below fair value—lead naturally to the idea of convertible arbitrage, where a long position in the convertible bond is balanced by a short position in the underlying equity.
What are convertible bonds used for?
Convertible bonds can be a great way for investors to get involved with a company that they believe in and to potentially make a profit if the company’s stock price increases. However, it is important to remember that convertible bonds are still bonds, and they come with all of the risks that come with any other type of bond.