Question

What does it mean when a bond is referred to as a convertible bond? Would a convertible bond be more or less attractive to a bond holder than a non-convertible bond?

Answer 1

Convertible bond:

Its a bond with a call option that gives bondholder an option to convert from debt security to equity (issuer's common stock)during a pre-determined period at a pre-set price.

Investors prefer convertible bond as they can participate in the potential upside returns of the common stock of the company. For this benefit, at times, bondholders usually accept a lower coupon convertible bonds.

Once bond is converted to common equity, bondholder will not recieve the coupon payments.

Ex:

Convertible bond will be specified with:

• Issue date
• Coupon interest on face value
• Conversion period
• Conversion ratio
• Issuer call price

Bondholder converts from debt to common stock, when the stock price is above the conversion price, and thus gain from the capital appreciation of the stock and forgo the lower coupons.