A convertible preferred share is similar to a convertible bond, but the shares can’t be converted into common stock until they are publicly traded. Once the preferred shares are publicly traded, they are converted to a fixed-income security with the same face value as the face value of the convertible security.

What Is a Convertible Security?

Most convertible securities are the basic stock-like units of equity, that investors purchase at the time they purchase stock in a company. In other words, these are units that can be changed into common stock at the offer or call time for one or more of the convertible security’s characteristics. A common use of convertible securities is as a means of leveraging the value of the common stock in a company. For example, let’s say a company is expected to go public and has a $100 million market cap.

How a Convertible Security Works

Convertible securities that are most commonly seen in the capital markets: Preferred Shares, Preferred shares are a very common convertible security in the United States. Preference shareholders can choose to convert the preferred shares into common stock on a daily basis at an automatic rate that is set by the company. This is because the preferred shares are a second tier stock on the public market and are often the best selling stock. Convertible Bonds, Convertible bonds allow the investor to take an interest in the company’s profits. If the company’s performance is good, the investors’ stake in the company’s profits can be maximized. If the company performs poorly, the investor has the right to buy common shares at the company’s redemption price.

Example of a Convertible Security

You can make an investment in a convertible bond. The underlying instrument is cash, which can be converted into common stock, and the rights are split between the lender, the bondholder and the shareholders. The company will make a payout every six months. Example of a Convertible Preferred Stock A convertible preferred stock allows the investor to choose to receive preferred stock, common stock, a fixed payment, or a combination of both. In addition to these alternatives, the investor receives dividend payments, which are paid twice a year. Convertible bonds are very simple instruments, but convertible preferred shares usually have some sort of protection for the investor against default by the corporation.

Advantages of convertible securities

• Conversion prices (called strike prices) can be as high or as low as the market rate of a company’s stock. This gives investors more flexibility, which makes it more likely that investors can profit from the stock’s growth.

• Convertibles pay income every quarter, just like common stocks. These dividends have been very important to retirees since companies have traditionally favored paying dividends to investors who are buying their stock as a place to get income.

• Convertibles are often more secure than common stocks. Since convertible securities are almost always used in high-risk markets, they have a higher standard of security and less risk. Conversely,

• Convertibles are much more volatile than common stocks.

Disadvantages of Convertible Securities

Convertible securities have a lot of advantages but one disadvantage that needs to be taken care of is the fact that the initial conversion price will be established when the security is first offered, which could be as high as the offering price. Therefore, the more attractive the initial conversion price is, the lower the value that the investor can expect when the security is eventually converted into common stock. Another disadvantage with convertible securities is that you can’t sell the underlying security as the price of the underlying is set at the offering price. Therefore, if the investor needs to sell his convertible security because of another reason, it is not possible because the price of the underlying would still be set at the initial offering price.