Convertible Securities. CPA Exam Questions. Intermediate Accounting Course.

IN this video, I discuss convertible securities. A convertible security is a security that can be converted into another security. Convertible securities may be convertible bonds or preferred stocks that pay regular interest and can be converted into shares of common stock
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What Is a Convertible Bond?
As the name implies, a convertible bond gives the holder the option to convert or exchange it for a predetermined number of shares in the issuing company. When issued, they act just like regular corporate bonds, albeit with a slightly lower interest rate.

Because convertibles can be changed into stock and, thus, benefit from a rise in the price of the underlying stock, companies offer lower yields on convertibles. If the stock performs poorly, there is no conversion and an investor is stuck with the bond's sub-par return—below what a non-convertible corporate bond would get. As always, there is a tradeoff between risk and return.

Why Do Companies Issue Convertible Bonds?
Companies issue convertible bonds or debentures for two main reasons. The first is to lower the coupon rate on debt. Investors will generally accept a lower coupon rate on a convertible bond, compared with the coupon rate on an otherwise identical regular bond, because of its conversion feature. This enables the issuer to save on interest expenses, which can be substantial in the case of a large bond issue.