Convertible bonds are corporate debt securities that generate a fixed income. These bonds are issued by corporations when there is a requirement for funding. You can convert these bonds into equities in the future and become a shareholder in the organisation.

 

Continue reading to learn about convertible bonds’ associated benefits and risks, when to convert these bonds, and more.

What are Convertible Bonds?

Convertible bonds work just like regular bonds, providing you with a fixed income on your principal. However, the difference here is that you can convert your debt investment into equities (shares) of the issuing company.

 

The conversion happens during the tenure of your bond and depends on the type of convertible bond you own. This conversion may also be compulsory if you have a mandatory convertible bond.

 

Once the conversion occurs, you become a shareholder and are no longer a bondholder. After conversion of bonds to equity, the returns will not be fixed and depend on the performance of the issuing company.

 

The number of shares you will receive depends on the conversion ratio mentioned in the bond. For example, if a conversion ratio is 15:1, you will get 15 shares against one unit of debenture. You will also mention the conversion price on the bond.

Types of Convertible Bonds

Here are the common types of convertible bonds you can invest in.

  • Mandatory Convertible Bonds

This bond needs to be converted into shares within a specific timeline. Here, the bond will have a predetermined date for conversion. In this case, you do not have the option to cash in. The number and value of shares will depend on the conversion ratio and price mentioned in the bond. 

  • Vanilla Convertible Bonds

Unlike the mandatory convertible bond, you can choose whether to convert your bond to shares or not. To decide the ideal time for conversion, you will have to closely monitor the issuing company’s stock.

  • Reversible Convertible Bonds

In this bond type, the issuer chooses when to convert the bond. The issuing company may decide to convert the bonds or offer the bondholders cash on maturity. This conversion happens based on the conversion ratio and price mentioned. 

Types of Convertible Bonds

Here are the common types of convertible bonds you can invest in.

Mandatory Convertible Bonds

This bond needs to be converted into shares within a specific timeline. Here, the bond will have a predetermined date for conversion. In this case, you do not have the option to cash in. The number and value of shares will depend on the conversion ratio and price mentioned in the bond. 

Vanilla Convertible Bonds

Unlike the mandatory convertible bond, you can choose whether to convert your bond to shares or not. To decide the ideal time for conversion, you will have to closely monitor the issuing company’s stock.

Reversible Convertible Bonds

In this bond type, the issuer chooses when to convert the bond. The issuing company may decide to convert the bonds or offer the bondholders cash on maturity. This conversion happens based on the conversion ratio and price mentioned. 

 

Features of Convertible Bonds

Listed below are some of the must-know features of convertible bonds.

  • Investors could become shareholders of the issuing company

  • Better returns upon conversion to equity

  • Conversion ratio and rate decide the number of shares and their price

  • Convertible bond interest rate is generally low

  • Comparatively low risk and volatility due to it being a debt instrument

Benefits and Drawbacks of Convertible Bonds

Knowing the pros and cons of convertible bonds gives you a holistic view of it, enabling you to make an informed decision.

 

Here are some of its advantages and disadvantages.

Benefits

Drawbacks

Fixed income until conversion

Comparatively low interest payout

Possibility of higher returns upon conversion

Equity dilution if bondholders convert

Low risk of default

Lower liquidity than other bonds

Ideal Time to Convert Bonds

The right time to convert your bonds into equities depends on the type of convertible bond you own. Preferably, the conversion should happen when the share value is higher than your principal investment (face value), including the interest you could earn.

 

 You will need to monitor the issuing company’s stock movement to gauge whether there is an upward trend or not. A favourable market implies that you can get better returns right now and potentially in the future as well.

Things to Consider When Investing in Convertible Bonds

Before you invest in convertible bonds, check out the following tips:

  • Align your risk appetite and the investment’s risk 

  • Look at the conversion ratio and price to gauge your investment’s future value

  • Evaluate the investment horizon to ensure it is in line with your goals

  • Ensure the conversion terms suit your investment goals

  • Verify the issuer’s credibility to secure your funds

 

Now that you know convertible bonds’ meaning and benefits, be sure to consider these factors before you invest. You should also prioritise diversification of your investments to mitigate the risks.

 

Bajaj Markets offers a one-stop solution for your investment needs. Easily choose from a variety of tools based on your risk appetite and investment needs.

Disclaimer

You are being redirected to the third party web-application. However, we would want to appraise you that “Investments in debt securities are subject to market risks. Please read all the offer related documents/information carefully before investing."

FAQs on Convertible Bonds

What is a convertible bond in India?

Convertible bonds are hybrid debt instruments that allow you to convert your debt investment into equities of the issuing company. Prior to conversion, this bond offers fixed income on your principal investment.

Are convertible bonds debt or equity?

A convertible bond is essentially a debt instrument. However, you can convert it into equity during the tenure at a specified time.

Why should you invest in convertible bonds?

A distinct feature of this bond is that you can convert your debt investment into equity at a specified time during the tenure. As the company valuation goes up, your returns may  increase since the investment would be in equity after conversion.

Are convertible bonds safe?

Like most bonds, a convertible bond is a low-risk instrument. However, there may be some general investment risk and conversion risk involved, wherein you may not receive the same value.

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