Convertible Bond
Quick Definition
A bond that can be converted into a predetermined number of the issuer's common shares, combining fixed income with equity upside potential.
What Is Convertible Bond?
A convertible bond is a hybrid security that starts as a corporate bond but gives the holder the option to convert it into a specified number of the issuing company's common shares at a predetermined conversion price. This dual nature provides downside protection through the bond's fixed coupon payments and par value guarantee, while offering upside participation if the stock price rises significantly. The conversion ratio determines how many shares each bond converts into — for example, a $1,000 bond with a conversion ratio of 20 converts into 20 shares (implying a conversion price of $50/share). Convertible bonds typically offer lower coupon rates than comparable non-convertible bonds because the conversion option has value. When the stock price is well below the conversion price, the convertible trades like a bond; when the stock is above conversion price, it trades more like stock. This creates a favorable asymmetric return profile that has historically delivered equity-like returns with bond-like volatility.
Convertible Bond Example
- 1Tesla issued convertible bonds at 2% coupon with $359 conversion price — bondholders converted when the stock exceeded $600, earning 67%+ gain
- 2A $1,000 convertible bond with 25:1 conversion ratio becomes 25 shares worth $1,500 when the stock hits $60/share
Related Terms
Corporate Bond
A debt security issued by a corporation to raise capital, paying periodic interest and returning principal at maturity.
Bond Yield
The return an investor earns from a bond, expressed as an annual percentage, which can be measured in several ways including current yield and yield-to-maturity.
Callable Bond
A bond that gives the issuer the right to redeem it before maturity at a specified price, typically when interest rates fall.
Bond Premium
When a bond trades above its face (par) value, typically because its coupon rate is higher than prevailing market interest rates.
Bond
A fixed-income debt security where investors loan money to an issuer in exchange for regular interest payments and return of principal at maturity.
Treasury Bond (T-Bond)
A long-term U.S. government debt security with a maturity of 20 or 30 years, paying semiannual coupon interest.
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