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Convertible Securities

Convertible securities are corporate bonds or preferred stocks that can be converted to common stock. They combine the income features of bonds with the growth features of stock. Companies issue convertibles to make their securities more attractive to investors.

By generating regular income, they provide a level of protection against losing money if stock values decrease, along with the ability to benefit from growth if stock values increase.

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.

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