Convertible bond

A convertible bond is a corporate bond that gives its holder the option to exchange it for a predetermined number of the issuing company's common shares, instead of receiving the bond's cash repayment at maturity. Until an investor chooses to convert, it behaves like an ordinary bond, paying a fixed coupon and carrying a set maturity date.

The conversion feature gives a convertible bond a hybrid character. If the company's stock price stays flat or falls, the bond behaves mostly like regular debt, and the investor still collects coupon payments and, absent a default, gets repaid at maturity. If the stock rises enough, the option to convert into shares becomes valuable, and the bond's price starts tracking the stock's upside as well. This combination lets a convertible bond offer some participation in a company's growth while retaining more downside protection than owning the stock outright.

Because of this optionality, convertible bonds typically carry a lower coupon than a comparable straight bond issued by the same company, the conversion right is worth something to the investor, so the issuer pays less in cash interest for it. Companies often issue convertibles when they want to raise capital more cheaply than an ordinary bond would allow, while accepting that some future dilution of shareholders is possible if the bonds are eventually converted into stock.