Convertible Bond

A convertible bond pays interest like a regular bond and repays its face value at maturity if not converted. But it also gives the investor the option to convert it into shares if the share price rises enough.

For example, a 1,000 convertible bond might be convertible into 40 shares, which sets an effective conversion price of 25 per share. If the share price rises to 30, converting would give shares worth 1,200, more than the bond's face value. If the share price stays low, the investor can keep the bond and receive interest and repayment.

Because of this valuable conversion option, convertible bonds usually pay lower interest rates than ordinary bonds from the same company. Companies use them to borrow more cheaply, while investors get downside protection from the bond features plus the chance to benefit from share price growth.

Convertible bonds can dilute existing shareholders if converted. Their value depends on interest rates, the company's credit quality and the share price and its volatility, which makes them more complex to value than ordinary bonds.