Definition
Convertibles are corporate securities, either preferred shares or bonds, that can be exchanged for a predetermined number of another form of securities, typically common shares, at a specified price. These securities offer the potential for equity-like returns while initially functioning as debt instruments.
Examples
Convertible Bonds: A company might issue a bond with a face value of $1,000 that can be converted into 50 common shares if the stock price reaches $20 per share.
Convertible Preferred Stock: A preferred stockholder might have the option to convert each preferred share into five common shares, offering growth potential if the company’s stock price appreciates.
Frequently Asked Questions
Q1: What is the conversion price? A1: The conversion price is the predetermined price at which the security can be converted into common shares.
Q2: What are the benefits of investing in convertibles? A2: Convertibles offer benefits such as potential higher returns from equity conversion and regular interest or dividend income until conversion.
Q3: How does a company benefit from issuing convertibles? A3: Companies benefit by attracting investors who are interested in equity-like profits while paying lower interest rates compared to traditional bonds.
Q4: What is a ‘conversion ratio’? A4: The conversion ratio indicates the number of common shares an investor will receive upon conversion of the convertible security.
Related Terms
- Conversion Price: The specific price at which the convertible security can be exchanged for common shares.
- Conversion Ratio: The number of common shares received when a convertible security is converted.
- Premium: The amount by which the price of a convertible security exceeds the conversion value.
Online References
Suggested Books for Further Studies
- “Convertible Securities: The Latest Instruments, Portfolio Strategies, and Valuation Analysis” by Tracy V. Maitland
- “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset” by Aswath Damodaran
- “Convertible Bonds: The Low-Risk, High-Return Alternative to Buying Stocks” by Randall T. Root
Fundamentals of Convertibles: Finance Basics Quiz
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