Why Do Corporations Issue Convertible Securities?

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Why Do Corporations Issue Convertible Securities?

When a corporation is seeking to raise additional capital, it may opt to issue convertible bonds rather than straight bonds, because it can offer the convertible bonds with lower interest rates. Investors are willing to purchase convertible bonds with interest rates lower than the current rates for bonds in order to acquire the conversion feature. Similarly, a corporation may opt to issue convertible preferred stock rather than straight preferred stock, because it can offer the convertible preferred stock with a lower dividend rate.

Things To Know

  • A corporation may issue convertible bonds because it can offer them with lower interest rates.
  • A company may force conversion in some cases.

Both convertible bonds and convertible preferred stocks are often more marketable than either straight bonds or preferred stocks. To obtain the convertibility feature, many investors are willing to pay a premium—in the form of a lower dividend rate in the case of preferred stock, or lower interest in the case of a bond.

Why companies might call their convertibles

Occasionally, a company will call, or redeem, its convertibles. In these cases, a call provision included in the issuing agreement specifies a date on which the company can redeem the convertible. When a company calls its convertible securities, the result is a forced conversion. The investor has any of several options: 1) to accept the call price the company is offering, 2) to sell the convertible security, or 3) to convert the convertible bonds or preferred stocks to common stock.

A company may force conversion when it can replace the convertibles by issuing additional common stock. A company generally may force conversion when the price of its common stock has risen rapidly above its call price.