Convertible note

A convertible note is a bond that the holder can exchange for common stock at a predetermined conversion price, usually set at a premium to the share price at issuance. If the stock rises above that level, the holder can convert and capture equity upside. If it does not, the note is repaid at par at maturity, like ordinary debt.

Because investors receive an embedded option, issuers can borrow at lower coupons than on straight debt, sometimes near zero. The trade-off is potential dilution if conversion occurs. Many convertibles are bought by hedge funds running convertible arbitrage, which buy the note and short the stock to isolate volatility, so a stock’s volatility and borrow availability affect pricing.

For allocators, convertibles matter for both credit risk and share count. Example: a company issues a five-year note at a 0.5% coupon with a conversion price 40% above the current stock price; if shares later double, holders convert into equity instead of taking cash.