Convertible Bond

A convertible bond is debt that the holder can convert into a fixed number of the issuer's shares (the conversion ratio), effectively a straight bond plus an embedded call option on the stock. Because investors pay for that option, converts carry lower coupons than comparable straight debt.

Key terms: the conversion price (typically set at a premium — often quoted in the 20–40% range, varying with the market — to the stock price at issuance), conversion ratio (par ÷ conversion price), and often issuer call provisions. If the stock rallies above the conversion price, holders convert and the issuer repays with shares (dilution); if not, the convert behaves like a bond and is repaid in cash.

Issuers use converts for cheaper coupons and to 'sell equity at a premium'; the costs are potential dilution and complexity. Many issuers pair converts with call spread overlays to raise the effective conversion price and offset dilution. In valuation, in-the-money converts are treated as equity (if-converted); out-of-the-money converts as debt.