Convertible Debt

Conversion price: the stock price at which the bond converts to equity (typically 20–40% premium to current price). Conversion ratio: par value / conversion price = shares received per bond. For example, a $1,000 par bond with a $50 conversion price converts into 20 shares. When the stock price exceeds the conversion price, the bond is 'in the money' and holders are likely to convert.

The primary advantage is a lower coupon rate — typically 2–4% below comparable straight debt. This reduces cash interest expense. Growth companies with volatile stocks use converts because the equity component compensates investors for credit risk. The trade-off is potential dilution: if the stock rises above the conversion price, bonds convert to equity, increasing shares outstanding and diluting existing shareholders.

In valuation, convertible debt is treated as debt if out-of-the-money (below conversion price) and as equity if in-the-money (above conversion price). For diluted EPS, the if-converted method assumes all converts are converted and adds back after-tax interest — but only if conversion is dilutive. In EV calculations, out-of-the-money converts are in total debt; in-the-money converts are excluded from debt and added to diluted shares.