1. 25 Investments: Introduction
  2. 25 Investments: American Depository Receipt (ADR)
  3. 25 Investments: Annuity
  4. 25 Investments: Art and Collectibles
  5. 25 Investments: Bonds
  6. 25 Investments: Cash
  7. 25 Investments: Closed-End Investment Fund
  8. 25 Investments: Common Stock
  9. 25 Investments: Convertible Bonds
  10. 25 Investments: Corporate Bond
  11. 25 Investments: Futures Contract
  12. 25 Investments: Life Insurance
  13. 25 Investments: The Money Market
  14. 25 Investments: Mortgage-Backed Securities
  15. 25 Investments: Municipal Bonds
  16. 25 Investments: Mutual Funds
  17. 25 Investments: Options (Stocks)
  18. 25 Investments: Exchange-Traded Funds
  19. 25 Investments: Preferred Stock
  20. 25 Investments: Private Equity
  21. 25 Investments: Real Estate & Property
  22. 25 Investments: Real Estate Investment Trusts (REITs)
  23. 25 Investments: U.S. Treasury Securities
  24. 25 Investments: Unit Investment Trusts (UITs)
  25. 25 Investments: Venture Capital
  26. 25 Investments: Zero-Coupon Securities
  27. 25 Investments: Conclusion

Convertible bonds are hybrid securities that offer features of both bonds and stocks. They are technically corporate bonds that can convert into common equity at a certain price. For instance, if the underlying common stock appreciates sufficiently, convertible bond holders have a right to convert, or exchange the bond for common stock shares.

If conversion levels are not reached, the investor has a bond that pays a coupon payment and matures, at which point the investor will receive his or her principal back. So, there is more downside protection than with a common stock, and more upside than a pure bond because of the conversion feature if the underlying stock appreciates sufficiently in value.

Because of the upside with conversion, convertible bonds typically offer a lower yield than regular bonds. In the case of corporate bankruptcy, since convertibles are ranked in the capital structure along with regular bonds, investors have a better chance of getting some of their money back compared to those holding common stock. (To learn more, see Convertible Bonds: An Introduction.)

Objectives and Risks

Convertible bonds offer a solid mix of downside protection, upside potential, and income. One risk associated with convertibles is that most are callable. In other words, the company can force convertible bondholders to convert the bonds to common stock by calling the bonds. This is called "forced conversion".

How to Buy or Sell It

Convertible bonds can be bought along with other individual bonds. However, supplies are limited and a relatively high number of issues are only available to institutional investors. For this reason, liquidity is lower, and investors could be better served by investing in more diversified convertible bond mutual funds.

Strengths

Best features of bonds and stocks

Upside potential with downside protection

Income generating features

Weaknesses

Liquidity is low

Callable features aren’t ideal

Lower yields than pure bonds

Key Considerations

Liquidity: Low

Historical Returns: High (with downside protection)

Inflation Protection: Medium (due to stock features)


25 Investments: Corporate Bond
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