Convertible Debentures

• Convertible debentures, commonly called convertible bonds, are no different in function from regular corporate bonds. They have a market price that fluctuates with prevailing interest rates, an underlying principal (par) value, a definite maturity date, and pay interim (coupon) interest payments at monthly or quarterly intervals through maturity. Convertible debentures differ in that they are not collateralized, or secured, like regular bonds, meaning that they carry a higher risk of nonpayment of interest and return of principal. The principal difference is the bond's convertibility feature, which allows the holder to exchange the value of the bond for shares of the issuing company's common stock. Unless otherwise specified, this option is non-compulsory and may be exercised at any time up until the bond matures.
  
  

Example

• To illustrate, suppose an investor who holds a convertible debenture decides that it would be to his benefit to hold the issuing company's stock as opposed to the bond and exercises the convertibility option. The issuing company then provides this investor with a number of shares, either commensurate with the market value of the bond or in accordance with a predetermined number in line with the bond's terms.
  
  

Advantages

• The investment values of stocks and bonds are affected by different variables in the economic climate, such as interest rates, corporate earnings, and demand. A conversion might make sense if a convertible bond's value declines due to a rise in interest rates promulgated by economic expansion. Under such circumstances, the issuing company's stock is likely to rise in value, making it more worthwhile for the holder to convert to stock.
  
  

Investor Implications

• In addition to the increased risk due to the absence of collateral, convertible debentures can only be converted from bonds into shares of stock once. In other words, once converted, the shares of stock cannot be converted back into a bond.
  
  

Company Implications

• The implications of convertible debentures for issuing companies differ from those of investors. For an issuing company, it is preferable for an investor not to convert to stock. This is because additional shares of stock represent an additional obligation for the company, regardless of whether the investor continues to hold them or not. By contrast, a bond represents a liability with a definite end date.