A:

In finance, a convertible bond represents a hybrid security that offers debt and equity features and risks. While a convertible bond can limit the interest rate risk, it usually exposes investors to an increased credit risk when compared to regular fixed-income securities. Also, convertible bonds can be used to reduce the downside market risk at the expense of typically lower liquidity than for equities. The value of a convertible bond fluctuates depending on the creditworthiness of the company and the value of the underlying stock. The busted convertible bond refers to a situation when the underlying stock trades significantly below the conversion price and the bond acts more like a debt than equity.

Convertible Bonds

A convertible bond allows investors to convert the bond into equity under specific conditions. Typically, the bond can be converted to a specified number of a company's shares if the current stock price exceeds the conversion price. The conversion premium on a convertible bond refers to the amount by which the conversion price exceeds the market price of the company. A convertible bond is a fixed-income security with an embedded option, and valuing it can be complicated.

Busted Convertible Bond

The price for a convertible bond may not fluctuate at all when the market interest rate changes if the conversion price is significantly lower than the market price. In this scenario, the bond behaves more like an equity. However, if the market price is significantly lower than the conversion price, typically by 50% or more, a convertible bond acts like regular debt. The convertible bond is considered busted, and its yield and price fluctuate mainly with changes in market interest rates and the company's credit quality, since the probability of conversion before maturity is deemed very low.

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RELATED TERMS
  1. Convertibles

    Securities, usually bonds or preferred shares, that can be converted ...
  2. Convertible Bond

    A bond that can be converted into a predetermined amount of the ...
  3. Conversion Value

    The financial worth of the securities obtained by exchanging ...
  4. Busted Convertible Security

    A convertible security that is trading well below its conversion ...
  5. Convertible Security

    An investment that can be changed into another form. The most ...
  6. Conversion Price

    The price per share at which a convertible security, such as ...
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