What are 'Convertibles'

Convertibles are securities, usually bonds or preferred shares, that can be converted into common stock. Convertibles are most often associated with convertible bonds, which allow bond holders to convert their creditor position to that of an equity holder at an agreed-upon price. Other convertible securities can include notes and preferred shares, which can possess many different traits.

BREAKING DOWN 'Convertibles'

Convertibles are ideal for investors demanding greater potential for appreciation than bonds provide, and higher income than common stocks offer. Convertible bonds, for instance, typically offer a lower coupon than a standard bond. However, the optionality of the bond to convert to common stock adds value for the bond holder.

There are three main types of investments: debt, equity, and some hybrid form of the two. Convertible securities fall into the hybrid category because they have cash flow features of both a bond and a stock.

Like other bonds, convertible bonds are considered debt. In exchange for the use of investor funds, the company agrees to pay the investor a set rate of interest referred to as the coupon rate. Unlike other bonds, convertibles also give the holder the right to convert the bond into shares of stock.

Investors like convertibles because they offer protection against heavy losses, but they also give up some value in appreciation. Most convertible bonds are callable, which means the company can force investors to convert. In this case, the upside potential on convertibles is not unlimited.

Conversion Rate

The rate at which investors can convert bonds into stocks, that is, the number of shares an investor gets for each bond, is determined by a metric called the conversion rate. The conversion rate may be fixed or change over time depending on the terms of the offering. A conversion rate of 30 means that for every $1,000 of par value the convertible bondholder converts, she receives 30 shares of stock. It is not always profitable to convert bonds into equity. Investors can determine the breakeven price by dividing the selling price of the bond by the conversation rate.

Example ConvertibleĀ Calculation

In this example, a convertible bond has a par value of $1,000 and a selling price of $800. Shares of this company are selling for $40. The share price at which the convertibility feature becomes profitable is calculated by dividing $800 by 30, the conversion rate. The answer is $26.67, which is much less than $40. An investor can decide to convert and take profit at this point. If the bond never becomes profitable, the holder receives the bondā€™s stated interest rate.

RELATED TERMS
  1. Forced Conversion

    A forced conversion allows an issuing company to make a security ...
  2. Market Conversion Price

    An investor's effective cost to purchase common stock when it ...
  3. Senior Convertible Note

    A senior convertible note is a debt security that contains an ...
  4. Premium Adjustable Convertible ...

    A debt instrument that combines a coupon paying bond with the ...
  5. Foreign Currency Convertible Bond ...

    A foreign currency convertible bond (FCCB) is a type of convertible ...
  6. Conversion Price

    The price per share at which a convertible security, such as ...
Related Articles
  1. 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.
  2. 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.
  3. Investing

    3 Best High-Yielding Convertible Bond Mutual Funds (LACFX, FACVX)

    LACFX,FACVX,VCVSX: Learn about three of the highest-yielding options available.
  4. Investing

    The Top 6 Convertible Bond Funds for 2016

    Take a look at convertible bond mutual funds that are well-positioned heading into 2016, and why investors might consider a convertible fund portfolio.
  5. Investing

    Introduction to Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
  6. Managing Wealth

    The Mandatory Convertible: A "Must Have" For Your Portfolio?

    Mandatory convertibles are a little understood security with some distinct advantages. Find out if they are right for you.
  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

    5 Inflation-Beating Bond Picks

    Look beyond traditional bonds when planning long-term. The alternatives can be extremely rewarding.
  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.
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 is dilutive stock?

    Dilutive stock is any security that dilutes the ownership percentage of current shareholders - that is, any security that ... Read Answer >>
Hot Definitions
  1. Return On Equity - ROE

    The profitability returned in direct relation to shareholders' investments is called the return on equity.
  2. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  3. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  4. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  5. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  6. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
Trading Center