A convertible bond is a type of debt security that gives bondholders the option to convert their bonds into a predetermined number of common shares of the issuing company. This conversion feature provides bondholders with the potential to participate in the appreciation of the company’s stock. Convertible bonds are a hybrid financial instrument that combines features of both debt and equity.

Key features of convertible bonds include:

1. **Bond Characteristics:**
– Like traditional bonds, convertible bonds represent debt issued by a company. Bondholders are entitled to receive periodic interest payments (coupon payments) and the return of the principal amount at maturity.

2. **Conversion Option:**
– The key feature of convertible bonds is the embedded option that allows bondholders to convert their bonds into common stock. The conversion option provides flexibility to bondholders, as they can choose to convert if the company’s stock price rises.

3. **Conversion Ratio:**
– The conversion ratio is the predetermined number of common shares that can be obtained for each convertible bond. It defines the conversion terms and is specified in the bond’s prospectus. For example, a conversion ratio of 20:1 means that bondholders can convert one bond into 20 common shares.

4. **Conversion Price:**
– The conversion price is the predetermined price at which the convertible bond can be converted into common shares. It is often set at a premium to the current market price of the common stock to provide an incentive for conversion.

5. **Conversion Period:**
– Convertible bonds typically have a specified conversion period during which bondholders can exercise the conversion option. This period may be open for a certain number of years or may be triggered by specific events, such as the company’s stock price reaching a certain level.

6. **Interest Payments:**
– Convertible bonds pay periodic interest to bondholders, similar to traditional bonds. The interest rate is fixed and specified in the bond agreement. However, the interest payments are usually lower than those of comparable non-convertible bonds, reflecting the additional value of the conversion feature.

7. **Dilution Risk:**
– The conversion of convertible bonds into common stock can lead to dilution for existing common shareholders. This is because the conversion increases the total number of common shares outstanding. However, the impact of dilution is often mitigated if the conversion occurs when the company’s stock price has risen.

8. **Hybrid Instrument:**
– Convertible bonds are considered hybrid instruments as they combine features of both debt and equity. Bondholders receive fixed interest payments and have a claim on the company’s assets, similar to traditional bondholders. However, they also have the potential to benefit from capital appreciation through the conversion option.

9. **Attracting Investors:**
– Companies often issue convertible bonds to attract investors who are interested in the income provided by fixed interest payments but also seek exposure to potential stock price appreciation.

10. **Market Conditions:**
– The attractiveness of convertible bonds can be influenced by prevailing market conditions, including interest rates and the performance of the equity market. In periods of low interest rates or bullish stock markets, convertible bonds may be more appealing to investors.

Convertible bonds provide companies with a flexible financing option and offer investors a unique combination of fixed income and potential equity upside. However, the decision to invest in convertible bonds depends on factors such as the issuer’s creditworthiness, the terms of the conversion option, and the investor’s risk-return preferences.