What is a Convertible?

A convertible is a car with a roof that can be opened or closed. Whether open or closed, a convertible offers the thrill of driving with the wind in your hair.


Investors benefit from convertible debt in that they earn interest payments and may gain capital appreciation. Companies use convertible securities to raise funds with less dilution.

Convertible Bonds

A convertible bond is a hybrid debt security that offers equity-like returns with the protection of a regular fixed income instrument. The bond purchaser has the right and obligation to convert the bonds into shares of the issuing company at a predetermined price on or before the maturity date. The number of shares to be converted is also predetermined by the company. Unlike conventional corporate bonds, convertible bonds typically have lower duration and thus are less sensitive to interest rates.

The bond portion of the convertible has similar characteristics to a conventional fixed income investment, with periodic interest payments and an ability to be redeemed for cash at the end of the term. The equity option component acts more like a stock, with the value increasing or decreasing based on the company’s earnings and growth prospects.

Generally, the terms of a convertible bond include provisions for adjustments to the conversion price in the event of bonus issues of shares, rights issues, capital distributions (full or above agreed dividend levels) or other events that may dilute the investor’s economic interest in the underlying share capital of the company. In these cases, the company’s equity option will be ratcheted upwards to compensate the bondholder for their reduced economic interest.

In addition, the terms of a convertible bond will often protect against adverse share price movements by setting a minimum share price below which the convertible will not be automatically converted. This is known as the bond floor.

Convertible Notes

As the name suggests, convertible notes allow startups to receive capital that converts into equity investments. They are typically structured as debt investments but include a provision that allows the principal plus accrued interest to be converted into shares of the company at an earliest date.

Investors can negotiate favorable conversion terms like a valuation cap or discount rate. They also have the ability to force a repayment of their convertible note investment at its maturity date if the company is unable to raise a qualifying priced equity financing round (QFE).

Unlike SAFE notes, the valuation that is used to determine the conversion price of a convertible note may differ from the valuation used for the priced equity rounds. This is to ensure that investors are not being diluted too much if the company raises multiple funding rounds over time.

The main disadvantage of convertible notes is that they can dilute startup equity by giving away future equity at a discounted rate. When coupled with a valuation cap, the discounts can be even higher.

The other downside is that it is not clear how these instruments are treated for tax purposes, and as such, it is advisable that startups carefully consider the pros and cons of using them. Additionally, investors should consult a tax advisor to be certain that they understand the implications of these transactions.

Convertible Stocks

In recent years, convertible securities have outperformed bonds and stocks with less volatility (Figure 5.1). Convertibles combine the upside appreciation potential of stocks and income yield of bonds. As illustrated in Figure 5.2, they are also less sensitive to rising interest rates than stocks.

A convertible’s investment value fluctuates in tandem with the price of the company’s common stock. A convertible’s conversion ratio determines how many shares of the underlying company’s common stock a bond at par can be converted into. Companies often pair convertible bonds with additional warrants that can be acted on at any time.

Like bonds, convertibles typically offer lower yields than corporate bonds at bond origination, but they may pay higher yields after conversion to common shares. In addition, if the issuer experiences financial difficulty, convertible bondholders receive payment before common shareholders. This can help reduce the risk of dilution.

In constructing a core convertible portfolio, careful consideration is taken to manage the issuer’s equity sensitivity and fixed income sensitivity. A bond that is highly equity-sensitive can experience downward movements in the stock market during a period of economic stress, while a high credit-sensitivity issuer can suffer from declining corporate fundamentals that can cause a ratings downgrade. Through active management and regular rebalancing, the Calamos team seeks to strike an appropriate trade-off between equity and fixed income sensitivities within convertible strategies.

Convertible Debt

Convertible debt, or CVD, is a form of financing that allows investors to earn interest on their investment while still having the option of converting it into equity in the company at a later time. Investors typically negotiate terms on the amount of company equity they will receive at conversion, along with a timeframe.

Investors that invest in convertible bonds are often attracted to them because of their capital appreciation potential. However, since they are a form of debt and not an equity investment, investors are exposed to the risk that the company may default on their interest payments. In addition, because the bond has a stock option attached to it, investors are also subject to changes in the company’s share price, which can affect their valuation.

Another advantage of CVD is that it helps startups to reduce dilution of existing shareholders. This is because when a startup raises a new round of equity, they have to issue additional shares to investors, which decreases their percentage ownership of the company—this is called dilution. When a convertible note is attached to the share offering, the initial investment can be converted into a higher amount of shares, which helps to offset this dilution. Furthermore, most convertible notes have warrants attached to them that give investors the right to buy additional shares at a discount to market value in the future.