What is a Convertible Bond?
Issuing bonds is a way for a business to raise larger amounts of finance from multiple investors. Bonds are more fully explained in our bonds payable tutorial.
A convertible bond is in effect a normal bond with a call option attached, the owner receives an interest payment (coupon payment) until maturity, and then has the option to convert the bond into shares in the business at a pre-agreed rate.
Due to the call option, a convertible bond tends to have a lower interest rate than a normal bond, thereby reducing interest payments for the issuing business. However, due to its hybrid nature (part equity, part debt), a convertible bond ranks lower than a traditional bond in the event of bankruptcy, and investors who buy convertible bonds therefore have less security and higher risk. The upside to the investor is the potential for gain on conversion of the call option.
A convertible bond is sometimes referred to as a convertible note, convertible debenture, or convertible securities.
For further information see the Wikipedia definition.
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