Convertible bonds are typically issued by companies that have high expectations for growth and less-than-stellar credit ratings. The companies get access to money for expansion at a lower cost than they would ♍have toꦆ pay for conventional bonds. Investors, in turn, get the flexibility of turning their convertible bonds into cash or stock shares.

A startup company with little current revenue 🦩and rapid growth potential might be an ideal ca🐻ndidate for issuing a convertible bond.

Understanding Convertible Bonds

A 澳洲幸运5官方开奖结果体彩网:convertible bond is a hybrid security that has some features of both a bond and a stock share. It pays interest at a set rate at specified intervals. But it can b⛄e converted to either cash or a specified number of common shares when it matures. The conversion option is available at preset times during the life of the bond.

Convertible bonds generally have a lower 澳洲幸运5官方开奖结果体彩网:rate of return than conventional bonds. They appeal to investors who like the option of exploiting an increase in the stock’s price or taking the cash, depending on which is the better deal when the bဣond matures.

The terms of the bond establish its 澳洲幸运5官方开奖结果体彩网:conversion ratio. That is, the ♔bond may be convertible to four or five shares of the company’s common stock. That would be a conversion ratio🔯 of 4:1 or 5:1.

Convertible bonds are an appealing option for 澳洲幸运5官方开奖结果体彩网:corporations as well. They can set the rates of return a bit lower than conventional bonds. And, when the convertible bonds mature,✨ some of them will be repaid in stock rather than cash.

There’s yet another bonus for the company: Th🍃e interest on convertible bonds is tax deductible.

The Drawback of Convertible Bonds

Corporations like convertible bonds because they lower their cost 🍨of capital. It’s a cheap way to borrow money to improve the business.

Nevertheless, there is a drawback. If many or most of the convertible bond holders convert to stock shares, the company’s shares in the market will be diluted. And that reduces the shareholders’ 澳洲幸运5官方开奖结果体彩网:equity value.

Clearly, a company can overdo convertible bonds.🦋

The Tesla Example

Convertible bonds are typically issued by firms with substandard credit ratings and high expected growth. For example, in 2014, 澳洲幸运5官方开奖结果体彩网:Tesla Motors (TSLA) issuꦏed $2 billion in convertible bonds to finance the construction of the Tesla Gigafactory in Nevada.

Tesla had reported low or negative earnings over its few years leading up to 2014. Raising capital for the project using standard bonds would have been prohibitively expensive, as investors would have demanded steep 澳洲幸运5官方开奖结果体彩网:interest rates in return.

With the conversion option, the interest rates on Tesla’s converti💧ble bonds ranged fඣrom 0.25% to 1.25%.

By mid-2020, the first section of the Tesla Gigafactory was up and running in the Nevada desert.

Tesla also issued convertible bonds in 2013, 2017, and 2019.

The Bottom Line

A convertible bond is a hybrid security offering investors the option to cash it in when its term ends or convert it to shares꧅ in a company. Companies with high growth expectations and subpar credit ratings typically issue convertible bonds, giving them access to money for expansion for less than they would have to pay for conventional bonds.