Convertible bond
Hybrid bond convertible into equity shares.
Wikipedia / Wikimedia Commons
A convertible bond is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features, originating in the late 19th or early 20th century.
- Origin
- Late 19th or early 20th century
- Common use
- Issued by established public companies
Lore & Background
Convertible bonds originated in the late 19th or early 20th century and were used by various early financiers. They are considered debt securities because the issuing company agrees to pay fixed or floating interest, but they offer the additional value of an option to convert the bond to stock, typically resulting in a lower yield than similar non-convertible debt.
Reader's Guide
Convertible bonds are significant as a hybrid investment vehicle that provides the potential upside of conversion into equity while protecting downside with cash flow from coupon payments and return of principal at maturity. From the issuer's perspective, the key benefit is reduced cash interest payments, and if bonds are converted to stock, the company's debt vanishes. However, this benefit comes with stock dilution for existing shareholders. Convertible notes are also a frequent vehicle for seed investing in startups, allowing conversion to equity in a future investing round without requiring early valuation of the company. The asset class includes various subtypes such as vanilla, mandatory, reverse, packaged, contingent, foreign currency, exchangeable, and synthetic bonds, each with distinct conversion terms and risk profiles.
Did You Know?
- Convertible bonds originated in the late 19th or early 20th century.
- A convertible bond typically has a lower yield than similar non-convertible debt to compensate for the option to convert to stock.
- Mandatory convertibles force the holder to convert into shares at maturity, with two conversion prices that create a risk reversal profile.
- Contingent convertibles are automatically converted into equity if a pre-specified trigger event occurs, such as asset value falling below guaranteed debt.
Frequently Asked Questions
What is a convertible bond?
A convertible bond is a hybrid financial instrument that blends debt and equity characteristics. The holder can choose to swap it for a predetermined number of the issuer's common shares or receive cash of equivalent value.
What makes a convertible bond different from a standard bond?
Unlike a plain bond that only pays fixed interest and returns principal, a convertible bond gives the holder the option to exchange it for equity in the issuing company. This dual nature means it carries both debt-like and stock-like features.
When did the convertible bond first appear?
The instrument traces its origins back to the mid-19th century. It was one of the earlier hybrid securities developed in financial markets.
Which early speculators used convertible bonds?
Jacob Little and Daniel Drew are notable early figures who employed convertible bonds as tools to push back against market cornering schemes. Their use of the instrument helped shape its early reputation in trading circles.
What is a common modern use of convertible bonds?
Today, convertible bonds are frequently used as a seed-investment vehicle for startups. They allow early investors to participate in a company's upside while retaining a debt-like safety net if the venture does not perform.
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