In our last session, we covered the structure of traditional convertible securities and defined some common terms used in the convertibles market. In this lesson, we'll look at the rationale behind why companies choose to issue convertible securities instead of straight bonds or equity, why convertibles are considered safer than common stocks and why you may want to buy convertible securities instead of common stocks. Capital financing through the issuance of convertible debt can be more advantageous for a company than an issue of straight debt or equity. The fact is, most convertibles are converted, turning debt into equity.
Companies issue convertibles as a cheaper source of raising capital.
Convertible debt normally comes to market at a lower rate than the prevailing interest rates. From the issuer's viewpoint, convertible debt can either be an alternative to equity or an alternative to the issuance of straight debt. As an alternative to equity, if the debt is converted, the result is that the company sold shares at a price higher than that obtainable through a direct issue of common shares. As an alternative to debt, the convertible has a lower probability of being converted but when redeemed, the company would have raised capital at a much lower cost than a straight debt issue. Why convertibles are lower in risk than stocks is easy to understand.