Convertible Bonds
A convertible bond is a corporate bond that can be exchanged for a set number of the issuer's shares. It pays interest like a bond but gains if the stock rises, so it is a hybrid of debt and equity — usually with a lower coupon than a plain bond.
Convertible bonds try to offer the best of both worlds: a bond's steady interest and repayment, plus a stock's upside. In return for the conversion option, investors accept a lower interest rate. Companies like them because they borrow more cheaply. This entry explains conversion ratios, conversion value and how convertibles behave.
- Category
- Bonds and Interest Rates
- Reading time
- 3 min
- Also called
- Convertible bond, Convertibles, Convertible notes
- Updated
Convertible bonds in plain words
A convertible bond can be converted into shares of common stock of the same issuer at a pre-set price.1
It is a hybrid security: like a regular bond it has a maturity date and pays interest, and if not converted it repays face value.2
Once converted, it loses its debt features and becomes ordinary equity.2
How a convertible works, step by step
Check the conversion ratio
Shares received per bond.
Work out the conversion price
Face value ÷ conversion ratio.
Calculate conversion value
Share price × conversion ratio.
Compare with the bond value
The bond is worth at least the higher of the two, roughly.
Collect interest meanwhile
Usually a lower coupon. See Coupon Rate.
Convert or hold
Convert when the shares are worth more.
Worked examples
Example 1 — Conversion price
$40 per shareA $1,000 bond converts into 25 shares.
| Conversion price | $1,000 ÷ 25 = $40 a share |
The bond can be exchanged for a predetermined number of shares, which sets an effective purchase price.2
Example 2 — Stock rises
+40%The stock climbs to $56.
| Conversion value | 25 × $56 = $1,400 |
| Gain vs face value | +$400 (+40%) |
When the shares rise above the conversion price, converting captures the equity upside.1
Example 3 — Stock falls
Bond floorThe stock drops to $25; the company stays healthy.
| Conversion value | 25 × $25 = $625 |
| At maturity | Repaid $1,000 face value |
If the investor does not convert, they receive the bond's face value at maturity.2
Convertible vs regular bond vs stock
| Aspect | Convertible | Regular bond |
|---|---|---|
| Interest | Lower coupon | Higher coupon |
| Upside | Shares if converted | None beyond par |
| Downside | Bond floor if issuer is healthy | Bond floor |
| Ranking | Usually above common stock | Above common stock. See Stock |
Who uses convertible bonds
Growth companies
Raising money with lower interest costs.
Cautious equity investors
Stock upside with a bond floor.
Convertible arbitrage
Buying converts, shorting stock. See Arbitrage.
Balanced portfolios
Between bonds and stocks. See Diversification.
Advantages and disadvantages
Advantages
- Equity upside with bond-like protection.
- Regular interest payments.
- Lower borrowing cost for issuers.
Disadvantages
- Lower coupon than straight bonds.
- Shareholders face dilution on conversion. See Share Dilution.
- The floor fails if the issuer gets into trouble.
Going deeper
Read as far as you need. Each level builds on the one before it.
Right or obligation
Beginner
Most convertibles give the investor a right to convert; some, called mandatory convertibles, require it.2
Capital structure
Intermediate
Convertibles are one of several corporate bond classes, alongside secured, unsecured and guaranteed bonds.1 See Corporate Bonds.
Option inside
Advanced
A convertible's price combines a straight bond's value with the value of a call option on the stock, so volatility and interest rates both matter. See Option Pricing Models.
Common mistakes
Ignoring credit risk
The bond floor depends on the issuer.
Forgetting call features
Issuers may force conversion.
Overpaying for the option
High premiums cut returns.
Overlooking dilution
Existing shareholders are affected.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Convertibles can be exchanged for shares.
- They are hybrids of debt and equity.
- Conversion price = face value ÷ conversion ratio.
- They offer upside with a bond floor.
- Coupons are lower than plain bonds.
Frequently asked questions
When should I convert?
Are convertibles safer than stocks?
Why do companies issue them?
Further learning
- Warrants
Another way to get equity upside.
- Share Dilution
The cost to shareholders.
- Callable and Putable Bonds
Embedded bond options.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- FINRA. Bonds (opens in a new tab) Checked .
- Corporate Finance Institute. Convertible Bond (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.