Introduction

A convertible debt is a debt security that can be converted into an equity at a later date. It is a hybrid financial product that combines the features of debt and equity. Convertible debts are issued in the form of debentures or debentures with a fixed maturity date and interest rate. The main feature of Convertible debts is the conversion option. It allows holders of bonds to convert them into shares at a predetermined price.

Characteristics of Convertible Debt

• Conversion Option

The main feature of convertible debt is the conversion option. This allows holders of the bonds to convert them into shares at a later date. Conversion options are typically exercisable by the holder of the bond and are subject to certain conditions, such as a minimum holding period and minimum conversion price.

• Fixed Maturity Date and Interest Rate

Convertible debt has a fixed term and a fixed interest rate. The maturity date is the date the debt must be repaid and the interest rate is the rate at which the issuer pays interest to the debt holder.

• Priority in Liquidation

In case of liquidation, convertible debenture holders have precedence over equity holders. This means that if the company goes into liquidation, the convertible bondholders will be paid out before the shareholders.

Merits of Convertible Debt

• Lower Interest Rates

Convertible debts typically have lower interest rates than other forms of debt such as bank loans and bonds. This is because Convertible debts may be converted into shares, giving the issuer the opportunity to raise shares at a later dat

• Flexibility

Convertible debt provides flexibility to issuers and investors. The issuer has the option to convert the debt into equity at a later date, allowing it to raise equity without diluting existing shareholders. Investors have the option to convert their debt into equity, giving them the opportunity to capitalize on potential profits from the company.

• Tax Benefits

Convertible debt provides tax benefits for both the issuer and the investor. Interest paid on Convertible debts is tax deductible for the issuer, reducing its tax liability. For investors, the conversion of debt into equity is not taxable, so they do not have to pay tax on the conversion.

Demerits of Convertible Debt

• Dilution

Convertible debts may dilute existing shareholders. This is because converting debt to equity results in the issuance of new shares, diluting the ownership of existing shareholders.

• Complexity

Convertible debts are complex financial instruments and require a high degree of expertise to understand. This complexity may make it difficult for some investors to assess the risks and benefits of investing in Convertible debts.

• Lower Returns

Convertible debts typically offer lower yields than equity investments. This is because the fixed interest rate of Convertible debts is lower than the potential return of equity investments.

Conclusion

A convertible bond is a hybrid financial instrument that combines the characteristics of debt and equity. There is a conversion option that allows the holder of the debt to convert it into equity at a later date. Convertible debts offer advantages such as low-interest rates, flexibility, and tax advantages, but also disadvantages such as dilution, complexity, and lower yields. Investors should carefully consider the risks and benefits of investing in non-convertible debentures before making any investment decision.