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Finance: What are Convertible Bonds? 9 Views


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What are Convertible Bonds? Convertible bonds are bonds that have a provision to be converted into equity common shares at a predetermined strike price. It is a means by which an investor can hedge a downside position by receiving coupon income and a return of principal at maturity on the bond, but benefit on the upside of stock appreciation via conversion if the listed market price rises beyond the strike price.

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Transcript

00:00

Finance a la shmoop what are convertible bonds? okay there's a joke about the

00:08

Inquisition in here somewhere or maybe something about Cossacks and 17th

00:13

century Russia what do you think animated musical or maybe a King Henry [King Henry VIII appears]

00:17

thing but yeah all that's different kind of conversion way more pedantically a

00:23

company might be having a hard time selling or issuing its bonds to Wall [Man with company briefcase for head meets man with Wall Street briefcase for a head]

00:29

Street in order for them to close the deal with their stock trading today at

00:33

25 bucks a share they might say well these bonds are convertible into 20 [Man with company for a head discussing bonds]

00:38

shares of our stock that is they would have a single thousand dollar unit of

00:43

that bond and it would convert into 20 shares which would then value the shares

00:48

at 50 bucks either thousand divided by 20 there's 50 it's an advanced calculus

00:53

sorry if you didn't have it which would sort of be you know the over/under price

00:56

at which bondholders would start to seriously look at converting their nice

01:01

safe bonds into those risky pesky equities well why would a company offer

01:06

convertible bonds instead of you know just vanilla bonds well if they were [Man discussing convertible bonds]

01:12

stuck paying 6% interest on just bonds but really could only afford to pay 4%

01:18

well they might get the interest rate discount by throwing in that equity

01:23

kicker in the bonds having that convertibility feature yes they would

01:27

suffer dilution at 50 bucks a share but that price is double and change where

01:32

the stocks out here so the company is probably thinking that it wouldn't mind

01:36

some dilution from these bonds being converted up there in stock price right [Arrow points to stock value mark on graph]

01:42

and remember the bonds pay the 4% interest along the way until they are

01:47

converted the moment those bonds are converted into equity well then the debt

01:51

on the balance sheet of the company and its obligation to pay that 4% yearly [Company balance sheet and interest highlighted]

01:56

interest goes mercifully away they print 20 more shares for each bond converted

02:02

and yes those shares may pay a dividend but as far as the convertible bonds go

02:07

they are thereafter converted and saved and remember Jesus Saves but Moses

02:15

invests

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