Bonds which can be converted into equity shares at a later date are called convertible bonds. Such conversion can occur at a price predetermined at the time of issue of bond or at the prevailing market price and the bonds which can not be converted into equity shares are called non‐convertible bonds.
Convertible bonds are in fact hybrid securities i.e. they carry the features of both equity and debt. Till the investor holds the bond, he receives interest periodically. However, once it is converted into equity shares, the investor enjoys benefits as an equity shareholder. This gives the bondholder both a fixed income investment with coupon payments as well as the potential to benefit from an increase in the company’s share price.
Since convertible bonds carry the additional option of conversion into equity share, the interest rate is usually less as compared to a non‐convertible bond. Some bonds are compulsorily convertible into equity shares after a particular period or on a particular date. Such bonds are called compulsorily convertible bonds.
Important Points to Take Care at the Time of Investment in the Convertible Bonds
- If you buy convertible bonds, ensure that you understand the conditions attached with it relating to the price of conversion, number of shares, the time period after which conversion can be made, etc.
- Check whether the bonds are compulsorily convertible & the conditions attached to it.
- Before investing in such bonds, analyze the returns that you would be earning from such bonds & ensure that they match with your return requirements.