What Are Convertible Securities?

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What Are Convertible Securities?

Convertibility is the ability of a security to be exchanged from one form to another. Convertibles are securities that can be exchanged for other securities issued by the same company.

Things To Know

  • Convertibility means to be exchanged from one form to another.
  • The company issuing the convertible sets rules for how it works.

What they are

Usually convertibles are either preferred stocks or bonds that can be exchanged for a company’s common stocks. Common stocks are units of ownership in a public corporation. Preferred stocks are another class of stocks that pay dividends at a set amount and take precedence over common stocks in the event of liquidation. Bonds are secured company debts, or IOUs.

How it works

When a company issues convertibles, it sets the number and price at which the conversion can take place. For instance, you may buy a $1,000 convertible bond that enables you to convert it to 20 shares of common stock at a price of $35 per share. Currently, the company’s common stock may be trading at $30 per share. The company usually sets the conversion price at about 15–20 percent above the current trading price of the common stock.

If the company’s common stock increases in value, you can make a profit by exchanging your convertibles for common stock. In the example above, you could make a profit by exchanging your $1,000 convertible bond for 20 shares of common stock when the price of the stock exceeds $35. Convertibles offer the potential of future profits if the price of the common stock rises to a certain point.