What is the purpose of convertible bonds?

Convertible bonds are corporate bonds that can be exchanged for common stock in the issuing company. Companies issue convertible bonds to lower the coupon rate on debt and to delay dilution. A bond’s conversion ratio determines how many shares an investor will get for it.

How does a convertible bond work?

A convertible bond pays fixed-income interest payments, but can be converted into a predetermined number of common stock shares. The conversion from the bond to stock happens at specific times during the bond’s life and is usually at the discretion of the bondholder.

Are convertible bonds safe?

One is that financing with convertible securities runs the risk of diluting not only the EPS of the company’s common stock but also the control of the company. To the corporation, convertible bonds entail significantly more risk of bankruptcy than preferred or common stocks.

How does a convertible bond work for a company?

A convertible bond is a fixed-income corporate debt security that yields interest payments, but can be converted into a predetermined number of common stock or equity shares. The conversion from the bond to stock can be done at certain times during the bond’s life and is usually at the discretion of the bondholder.

What happens to the par value of a convertible bond?

Par Value Par Value is the nominal or face value of a bond, or stock, or coupon as indicated on a bond or stock certificate. It is a static value at the maturity. However, if an investor converts the bonds to the company’s shares, the bond will lose all its debt features and then possess only equity features.

What does a 5 : 1 ratio on a convertible bond mean?

For example, a 5:1 ratio means that one bond would convert to five shares of common stock. A vanilla convertible bond provides the investor with the choice to hold the bond until maturity or convert it to stock. If the stock price has decreased since the bond’s issue date, the investor can hold the bond until maturity and get paid the face value.

Which is better convertible bond or equity financing?

If a company is not willing to dilute its stock shares in the short or medium term but is comfortable doing so in the long term, convertible bond financing is more appropriate than equity financing. The current company’s shareholders retain their voting power and they may benefit from the capital appreciation of its stock price in the future.