A:

A convertible bond is a bond issued by a corporation that, unlike a regular bond, gives the bondholder the option to trade in the bond for shares in the company that issued it. This gives the bondholder both a fixed-income investment with coupon payments as well as the potential to benefit from an increase in the company's share price. The additional value of the conversion option, however, will mean that the coupon payment on the bond will be lower than that of an equivalent bond with no conversion option.

A convertible bond issue, like that of other bonds, will state the maturity and the coupon on the bond. A convertible bond also has information about the conversion option, or how many shares will be received for the bond if it is converted.

For example, take a convertible bond that sells for $1,000. It has an annual coupon of 7% and can be converted into 100 shares at any time. Each year, the bondholder will receive $70 ($1,000 x 7%) as long as the bond has not been converted into shares. If the bondholder were to convert the bond into shares, he or she would no longer receive the coupon payment (interest), and the value of the investment would move with the price of the stock.

Based on the number of shares that will be received upon conversion and the price paid for the bond, the effective share purchase price can be calculated. In the example above, the effective price that the bondholder pays for the shares would be the price paid divided by the amount of shares received, or $10 ($1,000/100). The investor will only convert the bond into shares if the current share price is higher than the effective share purchase price.


An investor would, however, convert a bond into shares if the share value rose to $20. He or she would receive 100 shares and the market value of the shares would be $2,000. On the other hand, if the share price was $5, an investor would keep the bond and receive the payments on the bond because if converted, the market value of the shares would be only $500.

(For more about convertible bonds, read Convertible Bonds: An Introduction, Bond Basics Tutorial and Advanced Bond Concepts.)

RELATED FAQS
  1. What is the difference between convertible and reverse convertible bonds?

    The difference between a regular convertible bond and a reverse convertible bond is the options attached to the bond. While ... Read Answer >>
  2. What are 'death spiral' convertible bonds?

    Conventional convertible bonds give the bondholder the right to exchange the bond for a certain amount of the issuer's common ... Read Answer >>
  3. Where does the stock come from when convertible bonds are converted to stock?

    First, let's define convertible bonds. A unique combination of debt and equity, they provide investors with the chance to ... Read Answer >>
  4. How do I use a premium put convertible?

    Holders of convertible bonds face all the pitfalls that traditional bondholders face - liquidity risk, interest rate risk ... Read Answer >>
Related Articles
  1. Investing

    Convertible Bonds: An Introduction

    Find out about the nuts and bolts, pros and cons of investing in bonds.
  2. Financial Advisor

    Is Now the Time for Convertible Bonds?

    Convertible bonds offer a competitive rate of return in what is a very tough market right now. Here's how they work.
  3. Investing

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  4. Financial Advisor

    Worried About Stocks? Try on Convertibles

    Convertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).
  5. Investing

    Convertible Bonds

    A convertible bond is a bond the investor can exchange for a specific amount of company stock at a later date. It combines a bond and a call option. The bondholder can benefit if there's an increase ...
  6. Investing

    Leverage Your Returns With A Convertible Hedge

    Find out how you can maintain your income stream by using this type of bond strategy.
  7. Investing

    Convertible Bonds: Pros And Cons For Companies And Investors

    Find out why businesses choose this type of financing and what effect this has on investors.
  8. Investing

    Why Include Convertible Securities in Your Portfolio

    What are convertible securities and why you should include them in your portfolio.
  9. Investing

    The Top 3 Convertible Bond ETFs for 2016 (CWB, ICVT)

    Obtain detailed information on the exchange-traded funds (ETFs) available for traders seeking ETF exposure to convertible bond investments.
  10. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
RELATED TERMS
  1. Convertible Bond

    A bond that can be converted into a predetermined amount of the ...
  2. Convertibles

    Securities, usually bonds or preferred shares, that can be converted ...
  3. Revertible

    Refers to a special kind of convertible corporate bond that automatically ...
  4. Foreign Currency Convertible Bond - FCCB

    A type of convertible bond issued in a currency different than ...
  5. Premium Put Convertible

    A convertible bond with an additional put feature that allows ...
  6. Bond

    A debt investment in which an investor loans money to an entity ...
Hot Definitions
  1. Quadruple Witching

    The expiration date of various stock index futures, stock index options, stock options and single stock futures. All stock ...
  2. Co-pay

    A type of insurance policy where the insured pays a specified amount of out-of-pocket expenses for health-care services such ...
  3. Protectionism

    Government actions and policies that restrict or restrain international trade, often done with the intent of protecting local ...
  4. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  5. Demonetization

    Demonetization is the act of stripping a currency unit of its status as legal tender and is necessary whenever there is a ...
  6. Investment

    An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic ...
Trading Center