Convertible Bonds: How They Work, How to Value Them, and When the Floor Gives Way

A convertible bond is a bond with a call option on the issuer's stock attached. When the stock rises, the bond behaves more like stock; when the stock falls, it behaves more like a bond, as long as the company stays healthy. That shape is the whole appeal, and the condition at the end is the whole risk.

Convertibles have also become a much bigger market. US companies sold a record $131 billion of convertibles in 2026 by early September, per Bloomberg, beating the prior full-year record set in 2025, with AI-related companies a large share of the issuance.

The basic math

An illustration, a five-year bond with $1,000 par and a 1% annual coupon:

• Conversion ratio: 20 shares per bond
• Conversion price: $1,000 / 20 = $50 per share
• Stock price today: $40
• Conversion value (parity): $40 x 20 = $800
• Bond price: $950
• Conversion premium: $950 / $800 - 1 = 18.75%

Bond floor. If the issuer's comparable straight debt yields 6%, the present value of five $10 coupons and $1,000 principal at 6% is about $789. That is roughly what the convertible would be worth with no conversion right.

Now three scenarios at maturity or near it:

• Stock rises to $70. Parity is $1,400, and the bond trades at or above that. You gain about $450 on a $950 purchase, less than the stock's 75% rise but well over any bond return.
• Stock stays near $40. The bond moves toward par as maturity nears, and you collect a small coupon: a modest return.
• Stock falls to $20, credit intact. Parity is $400, but the bond should hold near its floor, which rises toward $1,000 as maturity approaches, because the company can still repay.

When the floor fails

The floor depends on the company's credit. Many convertible issuers are younger, unprofitable, or below investment grade. If the stock falls because the business is failing, the bond's credit spread widens at the same time, so the floor drops just when you need it. Bonds in that state are called "busted" converts and trade on recovery prospects.

2022 showed this at the market level. According to Calamos's market data, the ICE BofA All US Convertibles Index lost about 18.7% that year, as growth stocks fell and rising rates cut bond values. That was less than the losses in many of the underlying stocks, but it was not bond-like.

Terms that change the outcome

Read the offering documents or fund holdings summary for:

• Call provisions. Many convertibles let the issuer redeem early once the stock has traded above a trigger, commonly 130% of the conversion price for 20 of 30 trading days, after a period of call protection. A call forces holders to convert or accept the call price, which ends any remaining premium. Buying at a large premium close to the call date is how investors lose money on a rising stock.
• Settlement method. Many recent convertibles use net share settlement: the issuer pays par in cash and delivers shares only for the value above par. That changes dilution for shareholders but not the value to you.
• Capped calls. Issuers often buy capped call options alongside the offering to reduce dilution. They do not change your terms, but they can affect trading in the stock around issuance.
• Make-whole and fundamental change provisions. These give holders extra shares or a put at par if the company is acquired or delists, protecting the option value you paid for.
• Ranking. Most convertibles are senior unsecured, behind any secured bank loans. Some are subordinated.
• Mandatory convertibles. These, often issued as preferred stock, must convert at a set date, so they carry much more equity risk and no return of principal.

Measuring equity sensitivity

Delta is how much the convertible's price moves for a $1 move in the value of the underlying shares it converts into. Deep in the money, delta approaches 1 and the bond behaves like stock. Far out of the money, delta approaches 0 and the bond behaves like debt, if credit holds. The middle range, where delta is roughly 0.4 to 0.8, gives the "balanced" profile convertibles are known for. Fund managers often report the portfolio's average delta or describe holdings as equity-sensitive, balanced, or yield-oriented.

Convertible arbitrage

Hedge funds buy convertibles and short the issuer's stock in proportion to delta, adjusting as the stock moves. They profit from the coupon, from the stock's volatility being worth more than the price implied, and from the interest earned on short proceeds. They are a large share of buyers in new issues, which is one reason issuers can sell convertibles with low coupons. When arbitrage funds are forced to sell together, as in 2008, convertible prices can fall well below fair value. See our hedge fund strategies guide and volatility trading guide.

Why companies issue them

Convertibles let a company borrow at a lower coupon than straight debt, sometimes close to zero, in exchange for potential dilution. They suit high-growth companies with volatile stocks, since a volatile stock makes the option more valuable. Large issuance waves tend to come when stock prices are high. For issuers, the trade-offs are dilution if the stock rises and a debt maturity to refinance if it does not; see our strategic business debt guide.

Taxes

Interest is taxed as ordinary income, and bonds bought at a discount or issued with original issue discount create taxable accrual even without cash. Converting a bond into the issuer's stock is generally not a taxable event, and your basis carries over to the shares. Because the income is taxed as ordinary income, convertible funds often fit better in tax-deferred accounts.

Where they fit

Convertibles make sense as a partial substitute for equities for investors who want to give up some upside for a softer downside, or as a complement to a high-yield allocation. They are a poor substitute for high-quality bonds, because their losses tend to arrive at the same time as stock market losses.

When choosing a fund, check:

• average credit quality and the share of unrated issuers
• average delta or equity sensitivity
• concentration in technology and other growth sectors
• how the fund did in 2022 and in the 2020 sell-off
• expense ratio

For how convertibles fit alongside other assets, see our guides to portfolio rebalancing, high-yield bonds, and alternative investments.

This guide is for informational purposes only and does not constitute investment or tax advice. Convertible securities carry credit, equity, interest rate, and liquidity risk. Consult a qualified advisor before investing.