Lower and tax-deductible interest
A convertible bond is an investment instrument that has characteristics of both stocks and bonds. Technically, it may be viewed as the combination of a traditional bond and an embedded call option on the shares.
The buyer of the convertible bond has the right to convert the bond in exchange for shares. He will do so if it is advantageous for him: if the share is trading at a higher value than the conversion price.
Because of the conversion feature, the coupon of a convertible bond is generally lower than that of a straight bond. At maturity, the pay-off of the convertible bond depends on the price of the underlying share.
Companies often view convertible bonds as a cheap source of funding. If the bonds are not converted, they cost less than straight debt (lower interest rate due to the embedded call option). If they are converted, the conversion price is always set above the current market price at the moment of issue.
For investors, convertible bonds are often described as ‘the best of both worlds’: you receive regular interest payments as you would with straight bonds (even though these are a bit lower) and you also benefit from any rise in the value of the underlying share.