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A convertible bond (CB) is a type of bond that can be converted into stock of the issuing company at a pre-announced ratio. Like any bond, convertible bonds have an issue size, issue date, maturity date, maturity value, face value and coupon. They also have the following additional features:
• Conversion price: The nominal price per share at which conversion takes place.
• Conversion ratio: The number of shares each convertible bond converts into.
• Conversion premium: Represent the divergence of the market value of the CB compared to that of the parity value.
• Call features: The ability of the issuer to call a bond early for redemption, sometimes subject to certain share price performance. The intention is to encourage investors to convert early into equity (which has now become worth more than the bond's face value).
A convertible bonds have these characteristic:
• It typically has a low coupon rate, because the holder is compensated with the ability to convert the bond to common stock, usually at a premium to the stock's market value.
• When bondholders convert their bonds into new shares, the value of shareholder's equity is reduced due to the stock dilution. Ownership to company is decreased when bondholders convert their bond.
• Convertible bonds are safer than preferred or common shares for the investor. They provide asset protection, because the value of the convertible bond will only fall to the value of the bond floor.
• Convertible bonds can provide the possibility of high equity-like returns.
• Convertible bonds are usually less volatile than regular shares.
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