Convertible bonds

A convertible bond issued by a public company is one that starts as a bond but that can also be converted into ordinary shares in that company at any time before the bond matures, and at a previously specified price. In legal and accounting terms, until a convertible bond has been converted, it counts as a loan. Once converted, it is identical to other shares in issue and receives the same dividend. Convertibles usually provide a greater income than shares, but less income than a corporate bond. Holders of convertibles rank above ordinary shareholders in the pecking order in the event of a company going into liquidation. In general they can be seen as a compromise between the safety of bonds and the potential reward of equity. For the company that issues them – especially if it is a start-up – the fact that they tend to pay out a lower rate of interest than ordinary corporate bonds makes them a relatively cheap way to raise finance.

• See Tim Bennett’s video tutorial: What convertibles reveal about the stock market.

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