Henricks Corporation is considering issuing a convertible bond. What is a convertible bond, and what is the advantage of this type of bond to the bondholder and the issuing corporation?
A convertible bond is a bond that a company issues whereby the bondholder has the option to convert the par value of the bond into the company's common shares. The bondholder can do this at certain predetermined times. A convertible bond gives the bondholder the option of remaining a bondholder (a creditor) of the company, or switch to becoming a stockholder (part owner) of the company. This converting to becoming an owner of a company's shares is an attractive option for a bondholder if they see a company's stock is on the upswing. However, risk is still involved when it comes to taking an equity position in a company.
One advantage of a convertible bond to a bondholder is that a convertible bondholder must be paid before a standard issue bondholder is paid if a company experiences some type of financial collapse. Another advantage is that some bonds can be converted into a combination of stock and cash.
One advantage of a convertible bond to the issuing company is that they can raise capital, and do so without diluting the price of their shares at the time they undertake the issuing of the convertible bond. Another advantage is that the issuer can have some flexibility as to when they call bonds in. Some convertible bonds are callable convertible bonds. This can result in "forced conversions." These can take place on a predetermined set of dates.