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Convertible debentures are issued with the option of being converted into shares of common or preferred stock at any time.
This is an excellent feature when investing in companies that are in debt but expect to grow considerably over the next one to three years. In such instances, the ability to convert the debenture into shares of the company allow the investor to enjoy the security of the company's periodic interest payments, then convert his debt into common stock when the company's price begins to climb and enjoy the equity value benefit of rapid capital gains.
Because convertible debentures are often issued in anticipation of immanent growth, their yield is sometimes calculated in "all-in annual" terms, which take into account not only the bond's coupon, but also the capital gains that are anticipated from the successful performance of the company's stock in the marketplace. Yields of 25% per annum or higher may be quoted on convertible debentures. While such returns are certainly realistic, investors should be aware that such quotes are about as accurate as 52-week price targets in the stockmarket. Banking on returns like these from convertible debentures is as close to investing in the stockmarket as you can get while still pretending to be a bondholder.
Convertible debentures may be issued as either straight or subordinated, but it is more common for subordinated debentures to include the conversion feature, since it attracts investors with the option to exit this potentially risky long-term investment at their leisure.
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