Convertible Securities

A convertible is a fixed-income security that gives the holder the right, but not the obligation, to convert it into a predetermined number of the issuer’s ordinary shares on a certain date or over a specific period, subject to meeting certain conditions.

The decision to convert is exclusively for the security holder. There is no obligation for the holder to convert, and they are likely to choose to convert into shares if, at maturity, the value of the shares they can convert into exceeds the redemption value of the fixed-income security. Similarly, the issuer may also have the right to call (i.e., redeem) the issue if certain conditions are met.

This characteristic of multiple embedded options can make evaluating convertibles difficult. A convertible is like a hybrid of a corporate bond and a warrant, with the difference that in the case of exercising a warrant, the holder will have to pay cash, whereas, with the convertible bond, the payment is just the forfeiture of the bond itself in return for shares.