Convertible bonds: debt that can turn into shares
A convertible bond is an unusual mix of debt and equity: it starts as a loan but can turn into shares. This guide explains what convertible bonds and debentures are and how they work.
Quick answer
A convertible bond, or convertible debenture, is a type of debt that pays interest like a normal bond but can later be converted into a set number of the company's shares. It offers investors regular income plus the chance to gain if the share price rises, blending features of debt and equity.
Key takeaways
- A convertible bond is debt that can turn into shares.
- It pays interest like a normal bond until conversion.
- It can convert into shares at a set ratio.
- It blends features of debt and equity.
- It offers income plus potential share upside.
What is a convertible bond?
A convertible bond, also called a convertible debenture, is a form of debt issued by a company. Like a normal bond, it pays interest, but it also carries the option to convert into a set number of the company's shares.
So the investor starts as a lender, earning interest, but can become a shareholder if they choose to convert. This dual nature is what makes convertibles special.
How do convertible bonds work?
The bond sets out the terms of conversion, such as how many shares each bond converts into and when. Until conversion, the investor receives interest just like any bond holder.
If the share price rises well above the conversion level, converting into shares can be attractive. If it does not, the investor can keep holding the bond for its interest and repayment.
Why do companies issue them?
Companies issue convertible bonds because they can usually pay a lower interest rate than on ordinary bonds, since the conversion option adds value for investors. This lowers borrowing costs.
| Feature | Convertible bond |
|---|---|
| Starts as | Debt paying interest |
| Can become | Company shares |
| Appeal | Income plus share upside |
For investors, convertibles offer a balance: steadier income than shares, with a chance to benefit if the company does well and they convert.
What are the trade-offs?
The interest on a convertible is usually lower than on a plain bond, which is the price for the conversion option. And if the company does poorly, the shares may never be worth converting into.
Conversion also increases the number of shares, which can dilute existing shareholders. So there are trade-offs for both investors and the company.
How should investors view them?
Convertible bonds suit investors who want some income with a measured chance of share upside. They still carry credit risk and the effect of interest rates, like other bonds.
Understanding convertibles helps you weigh income against potential gains. Any investment decision should be your own after proper research and reading all related documents.
Frequently Asked Questions
What is a convertible bond?
A convertible bond, or convertible debenture, is debt that pays interest like a normal bond but can later be converted into a set number of the company's shares, blending debt and equity.
How do convertible bonds work?
The bond sets conversion terms such as how many shares each bond converts into and when. Until conversion the investor earns interest, and can convert if the share price rises enough.
Why do companies issue convertible bonds?
Because the conversion option adds value for investors, companies can usually pay a lower interest rate than on ordinary bonds, which lowers their borrowing costs.
What are the trade-offs of convertibles?
The interest is usually lower than on a plain bond, the shares may never be worth converting into if the company does poorly, and conversion can dilute existing shareholders.
Are convertible bonds risky?
They still carry credit risk and the effect of interest rates like other bonds, so they suit investors who want some income with a measured chance of share upside, after research.
Disclaimer: Investments in the securities market are subject to market risks. Please read all related documents carefully before investing. This article is intended for informational and knowledge purposes only and should not be considered tax, financial, or investment advice. Tax laws and deductions may vary based on individual circumstances and regulatory changes. Readers are advised to consult a qualified tax advisor or financial professional before making any investment or tax planning decisions.
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