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In finance, a convertible bond (or convertible debenture) is a type of bond that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio. It is a hybrid security with debt- and equity-like features. Although it typically has a low coupon rate, the holder is compensated with the ability to convert the bond to common stock, usually at a substantial premium to the stock's market value.
From the issuer's perspective, the key benefit of raising money by selling convertible bonds is a reduced cash interest payment. However, in exchange for the benefit of reduced interest payments, the value of shareholder's equity is reduced due to the stock dilution expected when bondholders convert their bonds into new shares.
The convertible bond markets in the United States and Japan are of primary global importance. These two domestic markets are the largest in terms of market capitalisation. Other domestic convertible bond markets are often illiquid, and pricing is frequently non-standardised
- USA: It is a highly liquid market compared to other domestic markets. Domestic investors have tended to be most active within US convertibles
- Japan: In Japan, the convertible bond market is relatively more regulated than other markets. It consists of a large number of small issuers.
- Europe: Convertible bonds have become an increasingly important source of finance for firms in Europe. Compared to other global markets, European convertible bonds tend to be of high credit quality.
- Asia (ex Japan): The Asia region provides a wide range of choice for an investor. Each domestic market within the Asian convertible bond market is at a various level of development.
- Domestics versus Euroconvertible bonds A further important classification is between the domestic and euroconvertibles markets. Euroconvertibles pay their interest gross and are free of transfer duty when bought, and are delivered into Euroclear or CEDEL for 7 day settlement. Domestics may have different settlement dates, they may pay their interest net of tax and be subject to transaction taxes. European euroconvertibles are generally highly liquid and have a pan-European investor base, dominated by hedge funds and proprietary desks. European domestic convertibles (such as in the UK and Italy) are dominated more by local investment institutions. Since the early nineteen-eighties, foreigners have been able to receive interest on U.S. domestic convertible bonds gross, and this has broadened the global investor base to embrace global hedge funds and other global investors. Likewise, foreigners have been able to receive interest gross on French convertibles (obligations convertibles or OCs), further blurring the differentiation between the domestic and euro CB markets. The pan-European CB market has substantially replaced the various domestic CB markets, and the driver behind this has been the ability of cross-border investors to receive interest payments gross.