Convertible notes are corporate bonds that can be exchanged for shares in the future, offering low interest rates to the company and potential benefits to investors. However, converting bonds into shares can dilute the value for current shareholders.
A convertible note is an investment that an investor can exchange for shares in the future. Most convertible instruments start out as corporate bonds issued by an organization. Bonds have a low interest rate, as the company does not want high interest rates for future payments before exchanging the instrument for stock. Domestic and international investors can benefit from these investments. Investment markets of the United States, Japan, Canada, Europe and Asia and have a wide range of convertible bond instruments that investors can buy in hopes of a future stock exchange.
Although these investment instruments look very attractive, they have some disadvantages in addition to their advantages. The first advantage for the company is the possibility of offering low interest rates on bonds. Investors buy these investments based on the hope of a future stock exchange, not a planned trade date. The company can then engage 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 auditors of the company will see this return as a good thing since the bonds won’t weigh too much on the company’s profits, assets or other financial information.
Another plus is the ability to immediately write off debts from the company’s books. High debt listed on the company’s balance sheet is never positive. Through the sale of convertible notes, however, the company can convert a large amount of bonds into stock, and the debt will go away with the stroke of an accountant’s pencil. While the company will need to provide a statement of financial statements to explain this transaction to all investors, the conversion allows for the reduction of debt from a convertible bond transaction to remove less value from the company’s assets.
A significant disadvantage to converting instruments of convertible notes into shares is the dilution of the current value for shareholders. All shareholders, from individual investors to financial institutions, will see their total investment value decrease as more shares enter the market from convertible bonds. Current shareholders will often not like the idea of losing value through this conversion. One way investors can mitigate this loss in value is to buy a portion of the convertible bonds offered by the company. When the conversion occurs, the total value of the shares should have less negative effects than the convertible bonds on a common exchange.
Smart Asset.
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