What Are Convertible Bonds?

By Sam Swenson, CFA, CPA – Updated Oct 9, 2025 at 1:53 AM

Key Points

Convertible bonds can be exchanged for a specific amount of common stock, offering potential profit if stock prices rise.
These bonds provide guaranteed income and priority in issuer default, but may have lower yields and increased risks.
Before investing, understand the terms and risks, as market conditions can affect convertible bond values.

A convertible bond is a type of debt security that allows investors to exchange their bonds for a specific number of common shares. Convertible bonds can be a good addition to a diversified portfolio, but they come with unique terminology and calculations. Here, we’ll define convertible bonds and explain the different types, as well as the pros and cons of owning them. We’ll also answer some frequently asked questions about convertible bonds.

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An infographic explaining the differences between vanilla convertible bonds and mandatory convertible bonds. — Image source: The Motley Fool

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Pros and cons of convertible bonds

Owning convertible bonds comes with various advantages and disadvantages. Here are the basic pros and cons:

Pros of convertible bonds

Optionality: Given uncertain bond and equity prices, many investors like the idea of being in control. If equity prices rise past the conversion price, an investor holding a convertible bond can exchange their bonds for common shares and earn a profit.

Guaranteed income: Although it may not be a tremendous amount of income, convertible bonds do provide guaranteed income nonetheless. In volatile equity markets, guaranteed income streams are all the more valuable.

Higher upside than corporate bonds: Even though convertible bonds will offer a lower yield than corporates at bond origination, they have the potential to more than make up for the difference upon conversion to common shares.

Protection from issuer default: If the bond hasn’t yet been converted, a convertible bondholder will be paid before common stockholders if the issuer defaults. Priority in liquidation can be an important feature in the event of unexpected financial trouble.

Diversification benefit: Hybrid securities such as convertibles (as well as preferred stocks) offer an added diversification benefit to a portfolio of standard stock and bond investments.

Cons of convertible bonds

Low yields: Relative to other corporate bonds, convertible bonds will offer a lower yield along with a conversion option. If the issuer’s stock price never reaches the conversion price, the investor may instead hold the bond until maturity at a lower yield.

Increased portfolio complexity: Retail investors may not have the inclination to add hybrid securities to a basic portfolio. If keeping things simple is a priority, convertible bonds may not be a good option.

Riskier than corporate bonds: Should the issuer enter bankruptcy, convertible bondholders will be paid back after most other classes of debt, including corporates.

High correlation to equity markets. Intermediate price movements within convertible bond security markets are highly correlated to stock prices, which may remove some of the advertised diversification benefit. Convertibles trading at or near their conversion price will display higher volatility.

Less liquid than other bond classes: Convertible bonds may trade in markets with greater bid-ask spreads, and as a result, less liquidity. Selling large blocks of convertible securities may be difficult to do without receiving a lower price for certain tranches.

What Are Convertible Bonds?

Key Points

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Your Complete Guide to Corporate Bonds

Understanding Treasury Bonds and Other Investments

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Our Guides

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The bottom line on convertible bonds