Convertible Debt Instrument
Convertible Debt Instrument

See Also:
Company Valuation
Coupon Rate Bond
Covenant Definition of a Bond Contract
Long Term Debt
Non-Investment Grade Bonds
Par Value of a Bond
Preferred Stocks

Convertible Debt Instrument (Bond)

A convertible bond is a debt instrument issued by a company that can be exchanged for shares of that company’s common stock. The price at which the bond can be converted into stock, or the conversion price, is typically set when the bond is issued. The bond can be converted at any point up until maturity.
Like standard nonconvertible bonds, issue a convertible bond with a set par value, maturity date, and coupon rate.
Convertibles are attractive instruments to investors because they combine the reliability of a debt instrument with the potential upside profits of shares of stock. If the company’s stock goes down, the convertible bondholder is not adversely affected. If the company’s stock goes up, the investor can profit from the conversion. The downside, however, is that a convertible bond will offer the investor a lower yield than a nonconvertible bond. This is because of the potential benefits of conversion feature. Convertible bonds are also typically callable, which means the issuing company can force the investor to convert the bond for a specified number of shares of stock at a certain price.

Issuing a convertible bond is an attractive financing option for a company because it is cheaper than issuing a nonconvertible bond. The benefits of the conversion feature allow the issuing company to pay a lower coupon rate to the bondholder. It is also a convenient way to raise funds without having to issue more common stock or standard debt instruments. On the downside, the convertible bond will dilute the company’s stock if converted.


Download The CEO's Guide to Keeping Score


Convertible Bond Premium

The convertible bond premium, or conversion premium, is the difference between the current stock price and the conversion price. For example, if a convertible bond can be exchanged for stock at $50 per share, and the current stock price is $45, then the conversion premium is $5.

Conversion Ratio Formula

The conversion ratio measures the number of shares of common stock the investor will receive in exchange for a convertible bond. The conversion ratio is often set at the issuance of the convertible instrument.

Conversion Ratio = Par Value of Convertible Bond / Conversion Price
For example, if the par value of the convertible bond is $1,000 and the conversion price is $50, then the conversion ratio equals 20. The investor could receive 20 shares of stock in exchange for each convertible bond.

Conversion Value Formula

The conversion value of a convertible bond is the value of the instrument in terms of the underlying stock. If the conversion value is greater than the par value, then the investor earned a profit. If the conversion value is less than the par value, the investor has made a profit.
Conversion Value = Current Stock Price x Conversion Ratio
For example, if the par value is $1,000, the conversion ratio is 20, and the stock price is $40, then the conversion value is $800. The investor would not want to convert. However, given the same par value and conversion ratio, if the stock price were $55, then the conversion value would be $1,100. In this case, the investor might want to convert the bond into stock and take the profit of $100.

The CEO's Guide to Keeping Score


convertible debt instrument

ARTICLES YOU MIGHT LIKE

The Accounting Gap Between Large and Small Companies

The Accounting Gap: It’s unfortunate, but true. A large gap exists between the accounting departments of large or publicly traded companies and smaller or private companies. In our past 25 years of consulting we’ve noticed that more often than not, these smaller/private companies will fill the gap with Bookkeepers, rather than the degreed Accountants/CPAs they

Read More »

The Struggles of Private Company Accounting

Building your Accounting Department… When I meet a business owner operating at a successful $10+ mil in revenue I often hear them say “My CPA…” and I immediately know they are referring to a tax CPA. One thing ALL entrepreneurs have in common is that they have to file a tax return. So from day

Read More »

Financial Ratios

See also:Quick Ratio AnalysisPrice to Book Value AnalysisPrice Earnings Growth Ratio AnalysisTime Interest Earned Ratio Analysis Use of Financial Ratios Financial Ratios are used to measure financial performance against standards. Analysts compare financial ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). The most useful comparison when

Read More »

JOIN OUR NEXT SERIES

Financial Leadership Workshop

MARCH 28TH-31ST 2022

THE ART OF THE CFO®

Financial Leadership Workshop

Days
Hours
Min

June 12-15th, 2023

SHARE THIS ARTICLE
WIKI CFO® - Browse hundreds of articles