Convertible debt

Convertible debt is a corporate bond that is convertible into the common stock of the issuer. In essence, it is a bond with an integrated stock option. This arrangement benefits the issuer, because investors will accept a lower interest rate in exchange for the conversion feature. The downside risk to the issuer is that bonds will be converted into stock, which may reduce the ownership interests of existing shareholders, and may also reduce the reported amount of earnings per share.

Investors take advantage of the feature when the stock price of the issuer increases to the point where converting and then selling the shares will result in a profit. This is also a low-risk investment for investors, since the worst case scenario is that they continue to receive interest payments, and will eventually have their bonds redeemed by the issuer. 

The conversion from debt to equity is conducted at a pre-determined conversion ratio, which may be applicable only within a certain date range. Conversion is not mandatory - a bond holder can elect not to convert to stock, even when the conversion would result in a profit.

Related Courses

Corporate Cash Management 
Corporate Finance 
Treasurer's Guidebook