What is a convertible bond?

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Convertible bonds are the most common type of bond issued by a company. As the name implies, these bonds can be changed into shares of the very same company’s stock at the bondholder’s discretion. Convertible bonds have both debt and equity characteristics, and they often generate more income than common stock, though not as much as corporate bonds.

Convertible bonds, like corporate bonds, have a set maturity date attached to them. When a bond is converted to equity, it loses all debt properties and gains only equity properties. If an investor does not want to convert the bond, he will only receive the bond’s face value when it matures.

To make bonds more appealing to investors, a company issuing debt could include a convertibility feature. By incorporating a convertibility feature, the company may be able to obtain a lower interest rate or a much better term.

A convertibility feature enables the investors to obtain a continuous flow of interest income while also having the possibility to profit from future stock price increases. Before investing, investors should always be cautious of the issuer’s credit ratings and the reinvestment risk if it is a callable bond. Before investing in a bond, investors should read the prospectus carefully.

The advantages of convertible bonds:

  • The issuing firm will save money on interest taxes.
  • Gives investors some protection against default risk.
  • Companies may be able to save money on their debt by paying reduced interest rates.

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Pieter Borremans
By Pieter Borremans

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