Convertible Bonds

Introduction

Companies can make significant income from convertible debt, such as convertible debentures or convertible bonds. Convertible debt instruments are a great way to source credit for businesses that want to grow and capture market share at breakingneck speeds or just recover from the pandemic.

What are convertible debentures and convertible bonds? Why are so many companies offering them in recent years. Let's see what we can learn.

Convertible debentures

Debentures, a type of unsecured debt, are an instrument of debt that firms offer to finance their business. Contrary to bonds, debentures do not have any collateral and are issued based on the creditworthiness only of the issuer. This means that if the company is unable to repay its debt, the lender would not be able to demand the liquidation of any physical assets. Convertible debt instruments are similar to debentures, but with one additional clause that the debentures can be converted into equity stock within the company after a certain time.

Convertible bond

Bonds are similar to debentures and can be issued by companies or firms to raise additional funds. bonds, however, are a type of secured debt. This means that if the amount is not paid, the company's physical assets can be sold to pay the amount. Convertible bonds work in the same way as convertible debentures. After a specified period, they can be converted to equity stock.

Why does a company issue convertible bonds or debentures?

Convertible bonds are generally offered by companies who predict rapid growth but have a lower credit rating. Both sides can benefit from this scenario. Convertible bonds can be issued by firms seeking capital raises. They are less expensive than traditional bonds. Because the bonds are convertible, they can be converted into stock or cash at specific times. Convertible bonds offer a great opportunity for lenders to receive some interest payments and still have the possibility of investing in the company if the stock price rises. A lender might pay 70% more interest than traditional bonds, but they would still be able to convert the bonds into stock if the price rises. This would allow them to reduce risk and capitalize on the opportunity cost.

Convertible debentures can be purchased by investors to offset their primary drawback, which is their unsecured nature. For example, if a company cannot repay traditional debentures debt, the lender will not be able to recover their money and they will lose their money. They could convert convertible debentures to company stock, and then sell those shares to regain some of their investment.

Convertible debentures can also be a benefit to firms. Convertible debentures not only offer lower interest rates, but also help companies save money. How do you do it? How? Convertible debentures allow lenders to trade their debentures to acquire a stake in the company. This means that they do not need to make cash payments. However, if there are too many lenders who trade their debenture coupon for stock, it can dilute the company's share price.

Conclusion

Convertible bonds or convertible debentures can be a great way for companies to raise funds at a lower interest than what they would normally have to pay. This is a great way for companies to save cash. However, it is not ideal for companies with limited revenue or companies that are newer than others and cannot raise capital at the market rate. Convertible bonds and convertible debentures are a way for companies to raise capital without exposing themselves to financial instability or unable to repay debt.