What is a Convertible Bond?

Today in this video we want to go over convertible bonds (convertible bonds). What is a convertible bond? Basically, it’s a corporate bond that the corporation issues and sells that has a lower interest yield on it, but with this added benefit or incentive—that the bond can be then converted into a particular number of shares of common stock in the issuing entity.

You get the benefits of a good upside and downside, potentially. There’s less risk, but with less risk you often get less reward. It’s a corporate bond that, if it goes to maturity and pays off, then it’s going to have a lower interest yield than a regular bond would, but hidden inside of it is this ability to convert it (to convert the bond) into shares of common stock in the company.

If the company takes off and starts doing well, then you can convert your bond into shares in the company and benefit from that. There is always, stipulated in the bond, a conversion price, so I’ve got an example on the board here. Let’s say the par price is 1,000 dollars, the conversion price is 20 dollars.

Take the par price divided by the conversion price and that gives you the number of shares it could be converted into, so in this case 1000 divided by 20 equals 50, and that can be expressed in a ratio of 50 to 1. Essentially what it’s saying is, no matter what the stock price does the bond will always be worth 50 shares, so you’ll always get 50 shares, no matter what the price happens to do.

You can also calculate the market worth (the bond price) is the number of shares times the conversion price. Basically, the thing to remember about convertible bonds is they are corporate bonds with a lower interest yield by themselves, but inside them is this capacity (or ability) to be traded (or exchanged) for common stock in the issuing company.

That can provide a good upside, It helps both the corporation, in terms of having people essentially remove the debt from the books by converting their bonds into stocks and things like this; and of course, if the company does well, then the person with the bond converts it to stock and they get to benefit in the company’s progress as well.

Convertible bonds are bonds that can be converted (or traded) for a particular set number of common stock in the company using this equation here: the par price divided by the conversion price (which is set in the bond) giving you the number of shares.