What is a 'Busted Convertible Security'

Busted convertible security refers typically to a convertible bond with an underlying stock trading well below its conversion price. As a result, the convertible bond trades as regular debt because there’s very little chance that it will ever reach the convertible price before maturity.

A convertible bond is a type of debt security that can be converted into a predetermined amount of the underlying company's equity at certain times during the bond's life, usually at the discretion of the bondholder.

BREAKING DOWN 'Busted Convertible Security'

Busted convertible security describes the behavior of a convertible bond which has lost considerable value as a potential convertible option. A convertible bond is a hybrid-type of corporate security that owners can exchange for shares of the company's common stock. Each bond has a face or par value that the owner can redeem for a fixed number of shares. The number of shares has a basis on the conversion ratio

For example, if a convertible bond has a face value of $500 and a conversion ratio of 10, every $50 of the face value would be redeemable for one share of company stock. That conversion feature can be useful to the owner if the value of the underlying stock increases before the bond they’re holding matures. Say the stock price of the company climbs above the conversion price of $50, to $60 per share. The owner could elect to convert their $500 bond (worth ten shares of company stock) into equity worth $600 (10 shares x $60/share). Once converted, the owner can hold that stock or sell it on the market. 

But if the price of the underlying stock decreases, falling below 50% of the conversion price, the security is ‘busted.’ In that case, the bond behaves much like an out-of-the-money option. Take the same example involving a $500 convertible bond. If the value of the underlying stock fell to $25, or lower, the benefit of the security’s convertible feature is almost worthless since it’s unlikely that stock price will recover. There’s no incentive for the owner to convert the security to equity because its investment value, or what a similar non-convertible bond would fetch on the market, is worth more than the conversion value. The conversion value is the amount realized by exchanging the bond for equity.

Trading Busted Convertibles

Some investors have found success in trading busted convertibles. While the probability of converting the security into stock is remote, busted convertibles typically trade at prices and yields similar to traditional non-convertible bonds of similar maturities and risk. Meanwhile, should the underlying company stock happen to rebound before maturity, the bond’s convertible value would also appreciate, and the security could become valuable.

  1. Convertible Bond

    A convertible bond is a bond that can be converted into a predetermined ...
  2. Market Conversion Price

    An investor's effective cost to purchase common stock when it ...
  3. Conversion Price

    The conversion price is the price per share at which a convertible ...
  4. Contingent Convertibles - CoCos

    A security similar to a traditional convertible bond in that ...
  5. Convertible Bond Arbitrage

    A convertible bond arbitrage is an arbitrage strategy that aims ...
  6. Conversion

    A conversion is the exchange of a convertible type of asset into ...
Related Articles
  1. Investing

    An Introduction to Convertible Bonds

    Getting caught up in all the details and intricacies of convertible bonds can make them appear more complex than they really are.
  2. 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.
  3. Investing

    Convertible bonds: pros and cons for companies and investors

    Understand what effect convertible bonds have on investors and companies. Find out the advantages, disadvantages, and what the issue means from a corporate standpoint before buying in.
  4. Investing

    Introduction to Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
  5. Investing

    CWB: SPDR Barclays Convertible Secs ETF

    Read an in-depth analysis of the SPDR Barclays Capital Convertible Bond ETF, which tracks an index of high-growth potential convertible bonds.
  6. Investing

    Why This Convertible Bond ETF Is Surging

    This convertible bond ETF is delivering impressive returns, but it has some risks too.
  7. Investing

    Update: Major Convertible Securities ETF (CWB)

    CWB is an interesting and liquid ETF investment option for investors seeking to increase exposure to U.S. convertible bonds.
  8. Financial Advisor

    Why a Roth Conversion May Make Sense Now

    Converting to a Roth IRA is a simple strategy that can help weave a silver lining from an otherwise financially mediocre year.
  9. Financial Advisor

    Strong Bond ETFs In A Bond-Eroding Economy

    The ETF boom has given the average retail investor the ability to add some alternative bond types to a portfolio.
  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. How is convertible bond valuation different than traditional bond valuation?

    Read about bond valuation, particularly the differences between how a traditional bond is valued and how a convertible bond ... Read Answer >>
  3. 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 >>
Hot Definitions
  1. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  2. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  3. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  4. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
  5. Watchlist

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
  6. Hedge Fund

    A hedge fund is an aggressively managed portfolio of investments that uses leveraged, long, short and derivative positions.
Trading Center