Meaning and definition of Convertible Security
A convertible security can be explained as an investment that can be changed into another form. The most common convertible security includes convertible preferred stock or convertible bonds, which can be transformed into common stock or equity. Moreover, a convertible security pays a sporadic fixed amount of money as a preferred dividend (in the case of convertible preferred shares) or a coupon payment (in the case of a convertible bond), and indicates the price at which it is convertible into common stock.
As explained by Investopedia, convertible securities generally feature a lower payout than what is offered by comparable securities which do not possess the convertible feature. Moreover, the performance of a convertible security is highly influenced by the price of the original common stock. Also, the degree of association rises as the stock price looms or exceeds the price of conversion. On the contrary, if the stock price is pining away far below the conversion price, an out of action convertible in the market dialect, the security will probably trade as a preferred share or a straight bond, for the prospects of conversion are considered as remote.
Convertible Security Applications
Generally, the convertible securities are issued by companies with the aim of raising money. Companies having access to conformist methods of raising funds, like public offerings and bank financings, might proffer convertible securities for specific business reasons. Companies which are not able to strike the traditional sources of funding might sometimes provide convertible securities as a method of raising quick money.
How do Convertible Securities work?
The working of convertible securities and the risks involved are stated below for your reference:
- The company offers convertible securities which are helpful to the holders in converting their securities into common stock at a discounted price at the conversion time.
- The more shares issued at the time of conversion indicate the higher dilution to the shareholders’ dilution. Moreover, the company will have more outstanding shares after the conversion, lower revenues per share, and the individual investors will possess proportionally less of the company.
- A greater dilution indicates a higher possibility of decline in the stock price per share thus resulting in greater number of shares required to be issued in future conversions. This mi9ght make it more difficult for the company to get other financing.