# Convertible notes

> Debt securities that pay interest and can be converted into a set number of the issuer's shares, usually at a premium to the share price at issue.

Source: https://www.quantisnow.com/glossary/convertible-notes
Topic: Glossary / IPOs and offerings
Also known as: convertible note, convertible bonds, convertible debt, convertible senior notes, converts
Last updated: 2026-10-27

Convertible notes are bonds or notes issued by a company that pay interest and can be converted into the company's common stock (or cash, or a combination) at a predetermined conversion price. Investors get downside protection from the debt with upside if the stock rises.

## How it works

The key terms are the coupon, maturity and conversion rate, stated as shares per $1,000 of principal. The conversion price, $1,000 divided by the conversion rate, is usually set at a premium to the share price at issue, commonly 20% to 40% for larger issuers. Because of the embedded option, the coupon is lower than on straight debt. Larger issuers typically sell converts in Rule 144A offerings to institutional buyers; many pair them with a capped call, a hedge that raises the effective conversion price and reduces dilution.

In microcaps, "convertible notes" often means something very different: toxic or floating-price notes that convert at a discount to the recent market price. These can lead to heavy, repeated dilution as the price falls.

## Why it matters for traders

Stocks often drop on a convertible offering announcement. Part of that is [dilution](https://www.quantisnow.com/glossary/dilution) risk, and part is hedging: convertible arbitrage funds buy the notes and [short the stock](https://www.quantisnow.com/glossary/short-selling) to hedge, creating selling pressure at pricing. Watch the conversion premium, the size relative to market cap, whether there is a capped call, and whether proceeds are used to repurchase shares concurrently. For microcaps, a floating conversion price is a major warning sign.

## Example

Hypothetical Northwind Software (NWSW) trades at $50 and issues $500 million of 1% convertible notes due in five years with a conversion price of $65, a 30% premium. The conversion rate is $1,000 / $65, or about 15.38 shares per note, so full conversion would create about 7.7 million new shares. NWSW falls 6% on the announcement as hedge funds short shares against the notes.

## FAQ

### Are convertible notes dilutive?

Potentially. If converted into stock, they add shares. Diluted EPS includes the effect of conversion when it reduces EPS.

### Why does a stock fall when a company issues convertible notes?

Investors weigh future dilution, and convertible arbitrage funds short the stock to hedge their purchase of the notes.

## Related terms

- [Dilution](https://www.quantisnow.com/glossary/dilution.md): The reduction in existing shareholders' ownership percentage and per-share claims on earnings when a company issues new shares.
- [Warrants](https://www.quantisnow.com/glossary/warrants.md): Securities issued by a company that give the holder the right to buy its shares at a set exercise price before a set expiration date.
- [PIPE (private investment in public equity)](https://www.quantisnow.com/glossary/pipe.md): A private sale of a public company's stock or convertible securities to selected investors, usually at a discount, registered for resale later.
- [Shares outstanding](https://www.quantisnow.com/glossary/shares-outstanding.md): The total number of a company's shares currently held by all shareholders, including insiders and institutions, excluding treasury shares.
- [Short selling](https://www.quantisnow.com/glossary/short-selling.md): Selling borrowed shares in the hope of buying them back later at a lower price, profiting from a decline in the stock.

## On Quantisnow

- [Live feed: Offerings](https://www.quantisnow.com/news/offerings)
- [Public offerings](https://www.quantisnow.com/categories/offerings)
- [Shelf offerings and dilution](https://www.quantisnow.com/guides/shelf-offerings-and-dilution)