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What is a convertible bond?

Convertible bonds or convertible debentures are forms of debt that can be converted into a specific amount of common stock. Debt securities such as bonds will often be associated with fixed interest payments that will be paid back on a periodic basis.

Therefore, when convertible bonds are converted into common stock, there will be an impact on the numerator (increase in interest income), and an impact on the denominator (conversion of bonds into more common stock). Similar to convertible preferred stock, convertible bonds will use the “if-converted method”.

However, unlike convertible preferred stock, it is important to understand that the tax rate will only apply to convertible bonds as the applicable interest income amounts will be calculated net of tax.

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  • What is convertible preferred stock?

    Preferred stock offers additional privileges to shareholders and are recognized separate from common stock. Convertible preferred stocks will have an impact on the EPS numerator as preferred dividends will no longer exist upon the conversion of preferred stock into common stock and will have an impact on the denominator as the conversion of preferred stock into common stock will increase the amount of common stock applied to the WACSO. Generally, this conversion method will always result in a dilutive result (decrease from basic EPS) and will be always be reported. When convertible preferred stock is the security in play, you should use the “if-converted method”.