Definition of 'Convertible Security'
An investment that can be changed into another form. The most common convertible securities are convertible bonds or convertible preferred stock, which can be changed into equity or common stock. A convertible security pays a periodic fixed amount as a coupon payment (in the case of convertible bonds) or a preferred dividend (in the case of convertible preferred shares), and specifies the price at which it can be converted into common stock.
Investopedia explains 'Convertible Security'
Convertible securities usually have a lower payout than that offered by comparable securities that do not have the conversion feature. Investors are willing to accept the lower payout because of the conversion feature, which is tantamount to a call option on the common stock. The conversion price - the preset price at which the security can be converted into common stock - is usually set at a price significantly higher than the stock's current price.
The performance of a convertible security is heavily influenced by the price of the underlying common stock. The degree of correlation increases as the stock price approaches or exceeds the conversion price. Conversely, if the stock price is languishing far below the conversion price - a busted convertible in market parlance - the security will likely trade as a straight bond or preferred share, since the prospects of conversion are viewed as remote.