A convertible debenture is a hybrid security: half-stock, half-loan. Companies issue convertible debentures as a means to raise money. Investors buy them, not due to their great interest rates (they’re low in contrast to traditional bonds), but also for the option of converting them into inventory –shares of their company–if the debenture matures.
Benefits for the Issuer
Convertible debentures are delicate loans for companies in need of capital to expand or maintain their businesses. They provide businesses with much-needed cash at excellent rates when traditional lenders might need nothing to do together.
Benefits for the Investor
Investors in convertible debentures get a fixed-income and the choice of buying inventory in an up-and-coming company. This is like getting your cake, eating it and becoming to get a different one if you do not like the taste. Investors buy convertible debentures in promising companies they’re not completely sure about. When the new venture booms, they money in their debentures for inventory. If business goes bad, they can always ask for their money back and keep the attention.
The conversion premium is the rate you use to convert the debentures from bonds to fully refundable stocks. The ratio determines the amount of shares you get for each bond. As an example, a conversion premium of 50:1 means you get 50 shares for each and every bond.
The downside for the issuer is, if their company does well investors are going to want to convert to inventory and become shareholders. This will dilute their ownership of the business. The main downside for investors is that convertible debentures are unsecured. If the issuing company goes bankrupt, they might have to wait in line behind secured creditors to get compensated. A second downside is the inherent complexity of convertible debentures, which can easily confuse investors. Investors have to keep a watch out for the rates of interest, which affect the worth of bonds, while retaining their additional eye firmly on the stock exchange, which determines the worth of the potential inventory hidden inside every debenture.