Convertible Bond Definition, Basics and Example
Convertible Bond Definition – “A type of bond which is convertible into specified number of shares of a company with a conversion price.”
So, the bonds that gives the right to the bond holder to convert the bond into common stock of a company is known as convertible bond. There is a conversion rate that is provided at the time of purchasing of the bond. The most important thing to note is that, the conversion price is always greater than the market price of the share of that company. The conversion ratio provides the total number of shares that a bond holder will be receiving while converting the bond to a stock.
Example of Convertible Bond
In order to understand the convertible bond definition, let’s discuss an example. ABC is a company whose bond’s par value is Rs. 2000 and it comes with option to convert it into common stock. Suppose the bond is attached with 7% interest rate. The maturity period is of 3 year. Now, assume, Ram buys the bond and receives Rs 140 for each year as interest. Now in third year, he decides to convert it into the stock. The conversion ratio is 30 shares. The current market price of the stock is Rs. 170. So the worth of investment now is 5,100 rupees.
Importance of Issuing Convertible Bond
Company issue a convertible bond to make the bond more attractive so that it attracts huge investor base. Firms get a lower rate of interest as well as better features for issuing convertible bonds. On the other hands, investors gets steady income and in future they can also take advantage of the increase in the stock price of the company. But it is very important that, before investing in any convertible bond, investor should properly review the bond prospectus.