Identification

Convertible bonds that corporations issue are debt securities issued that are convertible into common stock of the issuing company. As a bond, a convertible pays a regular rate of interest and has a face amount that will be paid to the bond holder at maturity. The conversion factor allows the bond holder to convert the bond into a specific number of company shares at the bond holder’s discretion. The number of shares each $1,000 convertible bond can be converted to is called the conversion ratio.

Significance

The Financial Times defines high-grade corporate bonds as those from issuers with credit ratings of AA or AAA. The ratings come from rating agencies like Standard and Poor’s or Moody’s. AAA and AA are the two highest credit ratings available. Bond issuer ratings of BBB and above are considered to be investment grade, so high-grade convertible bonds are from the best credit quality issuers.

Function

Convertible bonds prices are based on the coupon or interest rate paid, the credit quality of the issuer and the conversion ratio compared to the current stock price. High-grade convertible bonds will be priced to yield an interest rate lower than the corporation’s regular debt securities. The conversion ratio determines the stock price at which the bond converts. If a bond has a conversion ratio of 50, a $1,000 bond is divided by 50, giving a conversion price of $20. If the company stock is below $20 per share, the bond value will be determined by the bond characteristics. As the share price moves above $20, the bond value will be based on the stock price. For example, if the stock price for this bond was $25, the convertible bond would be worth at least $1,250.

Potential

References

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