Convertible notes are low-interest corporate bonds that can be exchanged for shares in the future, offering advantages such as low interest rates and debt reduction, but also disadvantages such as dilution of present value to shareholders. They are available in the investment markets of the US, Japan, Canada, Europe, and Asia.
A convertible note is an investment that an investor can exchange for shares at some point in the future. Most convertible instruments start out as corporate bonds issued by an organization. The bonds have a low interest rate, since the company will not want high interest rates for future payments before exchanging the instrument for shares. National and international investors can take advantage of these investments. The investment markets of the United States, Japan, Canada, Europe, and Asia have a wide supply of convertible note instruments that investors can buy in hopes of a future stock market.
Although these investment instruments sound very attractive, they have some disadvantages in addition to their advantages. The first advantage for the company is the ability to offer low interest rates on the bonds. Investors buy these investments in the hope of a future stock market, not a planned trade date. Therefore, the company can participate in debt financing with low interest payments on the debt. This increases the return on investment for the convertible note instruments sold. Other investors and reviewers of the company will see this return as a good thing, since the bonds will not weigh heavily on the company’s earnings, assets or other financial information.
Another advantage is the ability to instantly erase debt from the company’s books. High debt on the company’s balance sheet is never good. However, through the sale of convertible notes, the company can convert a large amount of bonds into shares, and the debt will disappear with the stroke of an accounting pencil. Although the company will have to make a financial statement disclosure to explain this transaction to all investors, the conversion allows debt reduction from a convertible note transaction to remove less value from the company’s assets.
A significant disadvantage to converting convertible note instruments into shares is the dilution of present value to shareholders. All shareholders, from individual investors to financial institutions, will experience a decline in total investment value as more shares of the convertible bonds enter the market. Current shareholders will often not like the notion of losing value through this conversion. One way that investors can mitigate this loss in value is to buy a portion of the convertible bonds offered by the company. When conversion occurs, the value of the total share should have fewer negative effects than common exchange convertible bonds.
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