How Convertible Bonds Work

The corporate convertible bond market had a very strong first half of 2025, the best since 2021 according to Debtwire. So what are convertible bonds and why do public corporates choose to issue them? There are many reasons -- to list a few: 1) lower interest payments than traditional debt, 2) fewer covenants and restrictions than bank loans, 3) no ratings required from ratings agencies, 4) faster timeline (1-2 weeks) to raise capital than traditional debt (4-6 weeks), 5) ability to market the securities to equity investors, 6) new initiating coverage from Wall Street research analysts.

As an example of how these bonds work, take the recent example of Lyft, which issued $500 million of convertible senior notes on September 5, 2025. Lyft managed to raise these bonds with a 0% coupon, meaning that the company will pay no interest on the $500 million that it is borrowing for five years. Given a five year treasury currently yields 3.6%, this appears to be quite a deal! Of course, these notes are convertible to equity at a certain share price, resulting in dilution similar to issuing equity so there is no free lunch.

The initial conversion price of the notes was at a 30% premium to the Lyft stock price so current equity investors would be diluted if the stock reaches 30% above the price at issue. However, Lyft entered into derivatives transactions to synthetically raise the premium, and this is a common occurrence with convertible bonds. The company entered into capped call transactions that raised the conversion price to $33.60, costing $42 million. The company is buying a call option at the initial $23.52 strike price and simultaneously selling a call option at the higher conversion price to a group of investment banks, and the result is receiving lower proceeds but reducing potential dilution.

Given the apparent attractiveness of these instruments, why do we largely see them only in certain industries and for certain financial profiles? Like any financial instrument, convertible bonds have a certain cost of capital. This cost of capital is lower for companies with more volatility which makes the bonds more attractive to buyers while more mature companies can raise traditional debt at a lower cost of capital. Therefore we most often see newly public companies who are not profitable enough to raise traditionala debt but for whom the market expects attractive future stock appreciation choosing to issue convertible bonds.