Definition
Convertible bonds combine fixed-income characteristics with equity upside through an embedded conversion option. They offer lower coupon rates than straight bonds because of the conversion privilege. When the stock rises above the conversion price, the bond behaves like equity. When the stock falls, the bond's fixed-income floor limits downside. This asymmetric profile makes convertibles popular with hedge funds.
functions Formula
Conversion Value = Conversion Ratio × Stock Price
lightbulb Example
A convertible bond with $1,000 face, 3% coupon, and conversion ratio of 20 shares. Stock at $40: conversion value = 20 × $40 = $800 (bond trades near par on fixed-income value). Stock at $60: conversion value = $1,200 (bond trades above par, tracking equity).
verified_user Key Points
- Lower coupon than straight bonds due to conversion option
- Equity upside with fixed-income downside protection
- Conversion ratio determines shares received per bond
- Popular with hedge funds for arbitrage strategies