All About Convertible Bonds

Corporate bonds are among the most sought-after investment options. Because they aren't subject to strict regulatory requirements, bonds can be a great way for companies to raise capital. Corporate bonds offer investors a way to earn a fixed rate of return, which is generally higher than that offered by banks. Companies may offer convertible bonds as well as regular bonds. Here's all you need to know about the meaning of a convertible bond.

What is a convertible bonds?

Convertible bonds are a hybrid corporate debt security. They include both equity and debt components. Convertible bonds are different from regular bonds, which can be redeemed at maturity. Instead of being redeemed immediately after maturity, the buyer has the right or obligation to convert the bond in shares of the issuing firm. The issuing company usually determines the number of shares and their value.

An investor cannot convert the bond into stock at any time during the bond's term. A convertible bond is very similar to a regular corporate bonds in all aspects. The convertible bond has a fixed term and pays interest payments at predetermined intervals. An investor who does not convert the bond into equity shares would be entitled to the bond's face amount upon maturity.

Convertible bonds

Let's now get to the point about the meaning of a convertible bond. Let's take a closer look at each one.

Regular convertible bond

These types of convertible bonds are preferred by companies. Convertible bonds are usually issued with a fixed maturity date, and a predetermined price for conversion. The issuing company pays investors periodic interest payments in return for their investment in these bonds until maturity.

The investor can choose to redeem the bonds at face value or convert them to equity shares at the predetermined conversion prices. These bonds do not give investors the obligation to convert.

Mandatory convertible bond 

These bonds are not like regular convertible bonds and the investor is required to convert them into shares in the issuing company at maturity. Mandatory convertible bonds make regular interest payments until maturity. After that, the bonds must be converted to equity shares. Companies often offer higher rates of interest for mandatory convertible bonds because investors are forced to convert their bonds.

Reverse convertible bond 

Both mandatory and regular convertible bonds have both the right and obligation to be converted. Reverse convertible bonds have the option to be converted into equity shares by the issuing company at a predetermined price. The issuing company can choose to convert the bonds into equity share or keep them, depending on the circumstances.

What are the benefits of convertible bond ?

Convertible bonds offer a few advantages to both the investor as well as the issuing company. Let's dive a little deeper.

To the investor

Convertible bonds offer investors dual benefits. Investors can enjoy stock value appreciation and a fixed interest rate on their investments until maturity.

Convertible bonds offer investors a lower risk of default. Bond holders are more likely to be given first preference in the distribution of liquidation proceeds if the issuing company goes under. Because their investments are almost guaranteed up to a certain degree, default risk is minimized.

To the issuing company

The issuing company can raise capital immediately without having to dilute shares as quickly as possible, which is not the case for equity financing. The company can technically postpone share dilution by issuing convertible bonds.

Because the investor is able to participate in the share price appreciation process, convertible bonds are generally offered at a lower interest rate than traditional corporate debt securities.

Conclusion

Convertible bonds can be a great way for investors to make high returns, but it is important to thoroughly analyze the issuer before you subscribe to their bonds. You must ensure that your investment is in a financially sound company capable of paying its debts when due. Before you purchase their bonds, take a look at their credit ratings.