What are Convertible Bonds?

The vanilla convertible bond is issued with a conversion price which is the price that the underlying stock must achieve for making the conversion profitable. The issue of the convertibles is in higher prices that are much higher than the underlying stock price. If the bond is converted, the unpaid accrued interest of the investor stands forfeited. Because of this, investors usually wait until entitled to the next interest payment before converting the bond into stock.

Convertibles have a call and put option embedded over it. A call option provides the right to the issuer to vigorously redeem the bonds before maturity for a pre-fixed price. The call date is often staggered across many years after the issue date. Call options do not appeal to investors, who need additional yield above the yields on basic convertibles or vanilla. Put options provide the investor the authority to sell the bond back to the issuer at an agreeable price. This creates a floor price on the bond which appeals to investors and thus lowers the desired yield on the bond. Many convertible bonds provide both options.

The mandatory convertible bonds are issued by the companies with a particular conversion date. The bonds are required to be converted by the investors to the underlying stock no further than this date. These bonds often have relatively short tenures.

The exchangeable bonds come up with a special trait where the underlying bond and the stock are from different issuers. Exchangeable bonds do possess all the other traits of convertible bonds.

These bonds must achieve a price above the conversion price before they get converted. The required price is often some fixed percentage above the conversion price, and the stock must trade at the required price for a pre-defined price before conversions are permitted.