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Bonds are fixed income instruments wherein the issuing company makes periodic interest coupon payments to its bondholders and repays the principal amount on their maturity dates. The company issues bonds to raise money for financing their long-term projects, expansion, refinancing existing debt and other activities. Among the various types of bonds in the stock market, convertible bonds and non-convertible bonds are two important categories. The two categories of bonds differ in terms of whether or not they can be converted into equity shares of the issuing company.
What are Convertible Bonds
Convertible bonds are a type of bond that can be converted into equity shares at the option of the bondholders. It can be either fully convertible or partly convertible. In the case of partly convertible bonds, the non-convertible portion of the bond will continue to carry interest payments until it is repaid at maturity.
Further, convertible bonds are categorized into compulsorily convertible bonds and optionally convertible bonds. Bonds that are compulsorily and automatically converted into equities of the issuing company at a specific tenure or on a certain event are referred to as compulsorily convertible bonds. Bondholders having the option to convert these bonds into equity shares are optionally convertible bonds.
Convertible bonds include the liability and equity component:-
| Liability Component | Principal redemption and interest payment liability |
| Equity Component | Convertibility option to the bondholder |
Terms specified at the time of issue:-
- Ratio of conversion, i.e., the number of shares exchanged for the converted portion, or
- Conversion price, i.e., the price at which equity shares are exchanged for the converted portion of the bonds, and
- Duration during which the conversion can be effected.
What are Non-Convertible Bonds
Non-convertible bonds are a category of bonds that do not have the option of conversion into equity shares and are therefore redeemed on the maturity date. The bondholders get periodic interest coupon payments (monthly, quarterly, annually or lump sum), offering better returns than fixed deposits. Further, as these non-convertible bonds do not offer any equity participation or ownership, they usually offer a higher coupon rate to compensate investors.
Non-convertible bonds are classified into secured and unsecured bonds. Secured non-convertible bonds are backed by the issuing company’s specified assets and on the other hand, unsecured bonds rely solely on the issuer’s financial health and are not backed by any specific assets of the issuer.
Convertible Bond vs Non-Convertible Bonds
| Distinction Factor | Convertible Bonds | Non-Convertible Bonds |
| Conversion Option | Can be converted into equity shares | Cannot be converted into equity shares |
| Returns | Interest plus potential for capital appreciation if the bond issuer performs well | Fixed interest rate and repays principal at maturity |
| Risk Profile | Riskier as the returns are also linked to equity market volatility | Lower risk and more stable |
| Ideal for Investors | Investors seeking both stability and capital appreciation | Investors seeking steady and safer income without the volatility of the equity market |
| Maturity Value | The maturity value of the bond depends on the price of the issuer’s equity shares at that time. | The maturity value is fixed and remains unchanged at the time of maturity. |
| Status | Both the owners and creditors of the issuing company | Creditors of the issuing company |
Summing Up
Convertible bonds are suitable for investors whose priority is capital appreciation and is comfortable with equity volatility. Non-convertible bonds are for those seeking stable, fixed rate income with lower risk.
Before Investing—
Before investing in convertible or non-convertible bonds, investors should check the issuer’s bond credit ratings, callable/puttable options, financial statements, liquidity, frequency of coupon payment, tax on bonds, etc., to ensure that it matches their risk appetite and financial goals. Further, one should compare the YTM of the bonds with varying maturities, prices and coupon rates to make informed decisions before investing in the bond market.
How to Invest—
Investors can buy bonds either during a public issue in the primary market or through stock exchanges, i.e., NSE or BSE, from the secondary market, where bonds are traded after issuance, using a trading and demat account. Investors can also invest through RBI Retail Direct or SEBI-registered Online Bond Platform Providers (OBPPs) for a streamlined and digital process. Alternatively, investors can also invest through Paisabazaar to invest in AAA-rated bonds to BBB-rated bonds and earn fixed returns of up to 13.25% p.a.