Handbook of Finance: Financial Markets and Instruments

Chapter 29. Convertible Bonds

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

STEVEN V. MANN, PhD

Professor of Finance, Moore School of Business, University of South Carolina

FILIPPO STEFANINI

Deputy Chief Investment Officer, Aletti Gestielle Alternative SGR Professor of Risk Management, Faculty of Engineering at Bergamo University in Italy

Abstract: Corporations finance themselves by selling claims to the expected future cash flows generated by their assets. The two basic claims issued are debt claims in the form of bonds and equity claims in the form of common stocks. Between these two endpoints, there exists a continuum of securities that possess features of both bonds and stocks. Among the most prominent of these hybrid securities is convertible bonds. A convertible bond is a combination of an option-free bond and the option to convert the bond into a given number of shares of the issuer's common stock. Convertible bonds may also be callable or putable or both. Depending on the performance of the underlying company, a convertible bond may behave more like a common stock or more like an option-free bond.

Keywords: conversion ratio, conversion premium, conversion price, hard put, soft put, conversion value, straight value, premium payback period, premium over straight value, fixed income equivalent, common stock equivalent, mandatory convertible, reverse convertible, convertible bond arbitrage

A convertible bond is a security that gives ...