Convertible Education

Definition of a Convertible

• A convertible security is a corporate bond or preferred stock with an embedded option that allows the holder to "convert" the bond or preferred stock into a fixed number of common shares of the issuing company.
• Like other corporate bonds and preferred stocks, convertible securities pay a fixed rate and convertible bonds have a maturity date.
• Convertibles have the added feature of allowing the holder to convert the security into common stock.

Convertible Derive Value from Two Sources

Equity Side

• The conversion value is the value of the common shares if the bond were converted today.
• Convertibles participate in upside appreciation of the underlying stock because of the conversion feature.

Bond Side

• The investment value is the value of the security if it were a straight bond without a conversion feature.
• Convertibles also provide a downside cushion because an investor can continue to collect the interest and principle if the stock declines.

Basic Characteristics of Stock, Bonds, & Convertibles

Benefits of Convertibles

• Convertibles provide equity-like returns with only part of the risk of owning common stocks thanks to a combination of upside participation, yield advantage and downside protection.
• Convertible securities capture a significant portion of the appreciation in common stocks.
• Convertible securities yield more than equities.
• Convertible securities are senior to equities in the capital structure and entail less downside risk than common stocks.
• Convertible bonds pay interest and repay principal at maturity; hence, the investor is protected on the downside if the underlying stock fails to perform.