by Raj Kumar

Created on: April 17, 2009

You might have heard the word "convertible" in relation to few financial terms like bond, adjustable-rate mortgages (ARM), preferred stock. If you have a bond which is convertible, you can convert it into common equity (issuer's shares) in future during the bond period and the conversion option will be implemented on your decision. Indirectly it means that you will gain the ownership in the company by the percentage value which would depend on the numbers of stocks you own. But then you should be more careful to be at more risky side as you would play in secondary stock market. Thus we can say that convertible bonds have a hidden stock option. Some of you may own preferred stocks of a company. By preferred stock, you might be aware that you would get regular dividend payments like interest payments in case of fixed bonds. If your preferred stocks are convertible then after a predetermined date, you would be able to convert them into a fixed number of common shares. Similar kind of situations is also present in case of loans.

You would guess that how loans can be convertible. But it is true nowadays. Basic concept behind it is that you can convert one type of loan to another if you wish. I have heard in case of structured finance and public finance. When we discuss structured finance, different types of loans trigger in our mind. These loans are asset-backed or mortgage-backed. Take an example of adjustable-rate mortgage (ARM). You might opt for ARM that too convertible. This would help you to lock in interest rate for certain period. You would ask why you would go for ARM. If the situation is not in your favor after a specified period and you perceive that interest rate might go up. In that tight position, you still desire to prefer stable payments then ARM would be beneficial as you can convert it into a fixed rate loan. The financial institution would charge a fee to switch the ARM to a fixed-rate mortgage. But don't forget that fixed rate repayments would be little higher than current market rates. You can also choose to convert the ARM in vice-versa mode i.e. from fixed rate to adjustable.

We all know that there is lot of competition everywhere. That competition is seen in banking and finance industry where lenders compete to offer different loan products. They try to make each product more attractive and flexible for you. Convertible loans are the outcome of these processes. People find these loans very handy as the changing face of economy has created fear

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