A convertible bond is a type of debt security that can be ‘converted’ into a predetermined amount of the company’s equity at certain times during its life. Usually, it’s a corporate bond that the holder can convert into common shares of the company or cash of equal value, at an agreed-upon price. It offers more potential for gain than regular bonds as they can take advantage of rises in the company’s share price.
1. Why would an investor consider a convertible bond?
An investor might consider a convertible bond for its potential for capital appreciation. When the company’s share price goes up, the price of the convertible bond will typically rise. Plus, if the stock performs poorly, they are still guaranteed to get their investment back, just like a traditional bond.
2. What happens when a convertible bond matures?
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When a convertible bond matures, if not converted into shares, it is repaid in full by the issuing company. If it has been converted, it is treated in the same way shares of stock would be, often leading to a cash payment or additional shares of stock to the bondholder.
3. How is the conversion price of a convertible bond determined?
The conversion price is decided at the time the convertible bond is issued and is typically set at a premium to the prevailing market price of the stock. The higher the premium, the more the stock must rise before the conversion option becomes valuable.
4. Can you sell a convertible bond?
Yes, a holder of a convertible bond can sell it on the open market just like any other bond. The price is dependent on a variety of factors, including interest rates, credit rating of the issuer, and the performance of the underlying stock.
5. What is a forced conversion of a convertible bond?
A forced conversion occurs when the issuing company calls the convertible bonds, forcing the bondholders to convert their bonds into shares. Companies may do this if the stock price is well above the conversion price, thus reducing their debt obligations.