Convertible Bond

Two terms define the equity side. The conversion ratio is the number of shares each bond converts into; the conversion price equals the bond's par value divided by the conversion ratio. A holder converts when the stock trades above the conversion price, because the shares received are worth more than the bond's face value. Below that, the holder keeps the bond for its coupon and principal — that's the 'bond floor' protecting the downside. The conversion price is typically set 20–40% above the share price at issuance (the 'conversion premium'), so the stock must rally meaningfully before conversion makes sense.

Issuers get a lower coupon than on straight debt because investors pay for the embedded equity option by accepting less yield — useful for growth companies wanting cheap financing without an immediate equity raise. Convertibles also let a company sell equity effectively above the current price (at the conversion premium) if and when conversion happens, and they're attractive when management believes the stock is undervalued today. The cost is potential future dilution: if the stock rises and bonds convert, existing shareholders' ownership is diluted. Investors like convertibles for the asymmetric payoff — bond-like protection on the downside, equity-like upside if the stock runs.

A convertible's value = the straight bond value (its bond floor, the present value of coupons and principal at a comparable straight-debt yield) + the value of the embedded call option on the stock. The market price trades at the higher of the bond floor and the conversion value (shares × current price), plus option time value. For EPS, convertibles are tested under the 'if-converted method' for diluted shares: you add the convertible shares to the denominator and add back the after-tax interest to the numerator, then report diluted EPS only if the result is dilutive (lower than basic). This is why convertibles can quietly inflate the diluted share count in a comparable companies analysis.