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.

Convertibles 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.

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