Basics of Convertible Bonds

The provision of conversion in a corporate bond entitles the bondholder the right to convert the bond into a predetermined number of shares of common stock of the issuer. Put differently, one can say that a convertible bond is a corporate bond with a call option to buy common stock of the issuer.

The number of shares of common stock that the bondholder can receive from exercising the call option of the convertible bond is called the conversion ratio.

The strike price or the exercise price at which the investor exchanges the bond for the share is called conversion price.

More often than not, most of the convertible bonds are callable at the option of the issuer. Some of the convertible bonds are puttable. The put options are further classified into hard puts and soft puts. If the convertible bond is redeemable by the issuer only for cash it is known as hard put. If the issuer has the option to redeem the convertible security for cash, common stock, subordinated notes, or for a combination of the three, then it is called a soft put.