Q&A: Investing in convertible bonds

Q: I'm considering an investment in convertible bonds. What are the risk-reward tradeoffs associated with these bonds?

A: Investors who think they're getting the best of both worlds with a convertible bond should be wary. It's true that convertible bonds may be converted to stock for a fee, often at the bond holder's discretion, but there are drawbacks associated with this type of investment. First, because they can be converted into stock, convertible bonds generally offer a lower rate of return than typical corporate bonds. So if the stock price doesn't rise, you're stuck with a bond that offers inferior returns. Further, most companies that issue convertible bonds have the right to "call" them at any time, meaning that the company can force you to convert the bond into stock. A company may do this when its stock price is higher than the bond's conversion price.