What is a convertible debenture?
A convertible debenture is a form of extended debt issued by a company that can be transformed into equity shares after a certain period of time. Typically, these debentures are unsecured loans or bonds without any collateral backing them.
These long-term debt instruments pay interest, just like regular bonds. What sets convertible debentures apart is their ability to be converted into company stock at specified times. This feature provides bondholders with some assurance, which can help reduce the risks associated with investing in unsecured debt.
Convertible debentures differ from convertible notes or bonds primarily in terms of their longer maturity periods.
Understanding Convertible Debenture
Companies typically raise funds by issuing either debt in the form of bonds or equity in the form of stocks. The choice between using more debt or equity depends on their capital needs and financial strategy.
Convertible debentures are a unique hybrid financial instrument blending characteristics of both debt and equity. When companies issue convertible debentures, they essentially offer fixed-rate loans to bondholders, ensuring regular interest payments. Bondholders face a decision: they can hold onto the debenture until it matures, receive their principal back, or they have the option to convert it into company stock. However, this conversion option is usually only available after a predetermined period mentioned in the bond's offering.
Convertible debentures tend to offer lower interest rates compared to traditional bonds. This is because investors are willing to accept reduced interest returns in exchange for the valuable option to convert their loans into common shares. By holding convertible debentures, investors get the opportunity to benefit from potential increases in the company's stock price