External sources of finance come from outside the business. Convertible bonds belong to external sources of finance. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance.
The amount of long-term finance needed for buying Fixed Assets, or Non-Current Assets, with a relatively low value such as vehicles will be small. While the amount of long-term finance needed for buying Fixed Assets, or Non-Current Assets, with a relatively high value such as new machinery for the assembly line will be large.
4. Convertible bonds
A convertible bond, or a convertible debenture, is a type of bond that the holder can convert into shares in the issuing company. Each bond can be converted into a specified number of shares of common stock in a limited company.
A convertible bond is a hybrid security with both debt-like and equity-like features. It usually has a maturity period greater than 10 years.
The conversion from the bond to stock can be done at certain times during the bond’s life. And, it is usually at the discretion of the bondholder.
What is so special about convertible bonds?
A convertible bond is a financial instrument that has both equity and debt characteristics.
- Debt characteristics: A convertible bond is a fixed-income corporate debt security that yields interest payments to the investor. The bond is like debt in that it has a fixed principal, fixed interest rate payable at fixed intervals, and a fixed maturity.Â
- Equity characteristics: But, it can be converted into a predetermined number of common stocks. So, the bond is like equity in that the holder can convert the debt into stock which is equity.Â
To sum things up, a convertible bond, or a convertible debenture, can be changed into shares after a certain period of time. This will happen, if the borrower requests it.
After the conversion, the issuing company will never have to pay the bond back. It is because it has already been transferred into shares.
