Convertible Bonds

Below are convertible bonds basics. Convertible bonds are bonds that the bond holder can exchange for another security. Usually convertible bonds can be exchanged for equity. Below is an example of how a convertible bond works. Some popular terms for convertible bonds are convertible preferred bonds, Eastern Europe convertible bonds, Boston Scientific convertible bonds and foreign currency convertible bonds.

Convertible bonds explained

If you have a convertible bond with a face value of $50,000 and matures in 5 years. Suppose this is a convertible zero coupon bond, then at the end of 5 years, you can either convert this zero coupon convertible bond to a common stock equivalent or just redeem the face value of the convertible bond.

Some convertible bonds can be converted at any time during the life of the bond but other convertible bonds will only allow you to convert to stocks at the end of the bond term. The more flexible the convertibility, the more valuable the convertible bond is.

Pricing of convertible bonds

Convertible bonds are priced according to the flexibility of their convertibles as well as the potential returns of the underlying stocks which they can convert to. Other bond pricing factors also come into play when pricing convertible bonds. When converting convertibles, the bond holder can trade his or her convertible bonds for an equivalent number of common shares at a set price. In our example above, the bondholder could receive 1000 shares for the zero coupon convertible bonds he exchanged. The convertible bonds could have fixed the number of shares rather than the price.

How to find convertible bonds

You can find convertible bond listings and also zero coupon convertible bonds through the brokerage houses. An example of zero-coupon convertible bonds is Liquid Yield Option Notes or LYONS which are Merrill Lynch 's proprietary version of a zero coupon convertible bond.