How They Work

The price of a convertible is based on many factors, including:

• The corporation's credit rating
• The price movement of its common stock
• Interest rates
• Call and put features

If the price of the common stock increases, the convertible's price increases by a percentage of the overall increase. If the price of the stock decreases, the convertible's price decreases by a percentage of the overall decrease. However, the convertible's fixed income adds to its upside potential and reduces the downside risk.

The owner of a convertible has the option, but usually not the obligation, to convert the security to a specified number of shares of the company's common stock. As a result, the investor can earn income, but also participate in the long-term appreciation in value of the stock.

Like other bonds and preferred stocks, convertibles sometimes can be called, or redeemed, by the issuer at a specified price before they reach maturity.