Convertible bonds

Definition

Convertible bonds are a type of bond that can be converted into a predetermined number of shares of the issuing company’s stock. They offer the benefits of fixed-income securities with the potential for equity appreciation.

5 Must Know Facts For Your Next Test

1. Convertible bonds provide interest payments like regular bonds until they are converted into stock.
2. The conversion ratio determines how many shares of stock each bond can be converted into.
3. Convertible bonds typically have lower interest rates compared to traditional bonds due to their conversion feature.
4. They offer a hybrid investment option, combining elements of both debt and equity.
5. Companies issue convertible bonds to attract investors by offering upside potential while reducing immediate interest costs.

Review Questions

• What is the primary advantage for investors holding convertible bonds?
• How does the conversion ratio affect the value of convertible bonds?
• Why might a company choose to issue convertible bonds instead of traditional bonds?

Related terms

Coupon Rate: The annual interest rate paid on a bond, expressed as a percentage of the face value.

Equity Dilution: The reduction in existing shareholders' ownership percentages caused by issuing new shares.

Call Option: A financial contract giving the buyer the right, but not the obligation, to buy an asset at a specified price within a certain period.