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Convertible bonds
give the holders a right to convert the bonds to a number of the issuer's
stock during a period, and at a price agreed at the time of issuing the
bonds. The coupon rate for such convertible bonds is typically lower
compared to a straight bond because the holder is given the right of
conversion.
The issuer thus benefits from
paying lower coupons and from maximising the proceeds received upon
conversion by setting a higher conversion price to its existing share price.
The investor also benefits if the company performs well; for then its shares
can be bought (through conversion) at what may prove to be a favourable
price (if the conversion price is lower than the market price at the time of
conversion). When the bond is converted to shares, it loses its principal
sum invested and the income from the coupons, but the investor who is now a
shareholder will benefit from payments of dividends and any future increase
in the share price.
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