Definition
The term convertible bond refers to an indenture issued by a company that is exchangeable for shares of common stock or the equivalent amount of cash. Convertible bonds are considered a hybrid security, since they contain both debt and equity features.
Convertible bonds are typically issued for a term of 10 years or more. As such, they represent a long term obligation of the company, and are shown in the long term liabilities section of the balance sheet.
Explanation
Issuing long-term bonds represents an important source of financing for many large companies. Convertible bonds typically carry maturities of 10 years or longer and are classified as long-term debt obligations.
Since this feature provides the investor the option of converting the bond into common stock or cash, it would carry a lower coupon rate than debt not possessing this feature. This type of security would be attractive to investors if they believed the issuing company's stock price will increase over time.
Companies that issue convertible bonds are usually smaller (in terms of market capitalization), with less-than-optimal credit ratings, that appear to offer significant growth potential. These securities offer the holder the opportunity for convertible arbitrage, which is taking a long position in the bond, while assuming a short position in the company's common stock.
Convertible bonds provide the issuing company with the opportunity to lower interest payments on its debt. In addition, as this debt is exchanged for common stock, the leverage of the company decreases. Unfortunately, this same mechanism decreases the value of common stock, as shares will be diluted when exchanged.
The prospectus of these securities will usually inform investors of factors such as the conversion price or ratio, redemption or conversion dates, in addition to the coupon rate and yield to maturity. Finally, convertible bonds may contain additional features such as the ability for the issuing company to redeem, or call, the debt prior to its maturity.
Related Terms
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The financial accounting term liability is used to describe the debt of a corporation that results from a transaction involving the transfer of an asset or the provision of a service. Liabilities are reported on a company's balance sheet.
Moneyzine EditorJanuary 23rd, 2024- The financial accounting term long term debt is defined as the loans and other debt obligations of a business that are payable in twelve months or longer. Long term debt appears in the liabilities section of a company’s balance sheet.Moneyzine EditorNovember 29th, 2022
The financial accounting term interest expense is used to describe the interest payments that have come due on amounts borrowed by a company or an individual. Interest expense will appear as a line item on a company's income statement.Moneyzine EditorJanuary 22nd, 2024- The financial accounting phrases term and serial bonds refer to indentures or contracts entered into by companies that represent a promise to pay. The maturity of bonds payable can be of two forms. Term bonds mature on a single date, while serial bonds mature in installments.Moneyzine EditorSeptember 21st, 2023
The term dilutive securities refers to financial instruments that are not in the form of common stock but can be converted to common stock. Examples of dilutive securities include convertible bonds and preferred stock, warrants and stock options.Moneyzine EditorJanuary 16th, 2024- The financial accounting term valuing convertible debt refers to the process of determining the cost assigned to these securities at the time of issuance and conversion. While the method used to value convertible debt when issued is similar to that of non-convertible securities, the market value or book value approach can be used at the time of conversion.Moneyzine EditorSeptember 21st, 2023
The financial accounting term market value method refers to one of two approaches to valuing a transaction involving the conversion of bonds to common stock. The market value method uses the current market value of either the company's common stock or the bond when recording the transaction.Moneyzine EditorFebruary 8th, 2024
The financial accounting term book value method refers to one of two approaches to valuing a transaction involving the conversion of bonds to common stock. The book value method uses the current book value of the company's bonds when recording the transaction.Moneyzine EditorJanuary 9th, 2024
The term induced conversions of convertible debt refers to a process whereby an issuer desires to encourage the conversion of debt to equity. Induced conversions typically include a "sweetener" such as additional stock or cash.Moneyzine EditorJanuary 22nd, 2024
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