Final answer:
Convertible bonds give the lender the right to convert the bond into common stock. This type of bond combines the features of both bonds and stocks, giving the bondholder both security and potential for increased return.
Step-by-step explanation:
Convertible bonds allow the lender to convert each bond into common stock. This type of financial instrument offers a combination of the characteristics of both bonds and stocks. It provides the safety of a bond, with the added benefit of being able to participate in the company's stock price appreciation.
When a firm decides to access financial capital, it has various options such as borrowing from a bank, issuing bonds, or issuing stock. Issuing a bond requires the firm to commit to scheduled interest payments. A convertible bond, however, provides the bondholder with the option to convert their bonds into shares of the company's stock, which could be beneficial if the stock's value increases over time.