By Shashank Pattekar, International Banker
In May, onsemi issued $1.5 billion of 0-percent convertible notes due in 2031. Instead of paying regular interest on the debt, the US semiconductor manufacturer offered investors exposure to gains linked to its share price. The transaction represents just one of hundreds of convertible notes issued this year, demonstrating the growing popularity of a financing structure that can reduce interest expenses when more conventional borrowing remains costly. But exchanging immediate interest savings for potentially sizeable future obligations nonetheless raises the pertinent question of just how much companies are ultimately willing to pay to borrow so cheaply.
A conventional convertible bond combines a loan to a company with an option for the lender to convert that debt into shares of that company on specified terms.
A conventional convertible bond combines a loan to a company with an option for the lender to convert that debt into shares of that company on specified terms. If the lender does not convert its bondholding into equity, it retains a contractual claim on the company to repay the bond at maturity, along with any scheduled interest. However, to gain the opportunity to benefit from share-price appreciation, it typically accepts a lower coupon rate than a comparable bond without conversion rights.
Contracts usually specify when conversion is permitted and whether investors receive shares, cash or both. The conversion price thus helps to determine the relative appeal of converting, although it does not automatically trigger an exchange as soon as the stock reaches a specified price.
For investors, convertibles are attractive because the debt component provides scheduled interest, where applicable, and a claim to repayment if the bond is not converted. Moreover, a rise in the issuer’s share price gives the investor the option to participate in equity gains. This combination can produce a more favourable balance between potential upside and downside risks than investing directly in shares, although the issuer’s creditworthiness plays a crucial role in determining the degree of protection the investor receives from the bond component.
Different investors pursue this opportunity in different ways. Long-only asset managers may buy convertibles to gain exposure to growing companies while accepting less direct equity risk. Convertible arbitrage funds commonly buy the bond and short some of the issuer’s shares, seeking to profit from relative movements between the two positions and changes in volatility rather than relying entirely on share-price appreciation.
The balance between debt and equity exposure also changes over the life of the bond. As the share price rises towards and then beyond the conversion price, the convertible generally behaves more like the underlying equity. When the share price falls well below the conversion price, its value depends more heavily on interest rates, the issuer’s credit quality and the likelihood of principal repayment.
Eli Pars has emphasised the importance of recognising these differences when selecting securities. “We’re also being selective about company fundamentals and conscious of position size,” the co-head of convertible strategies at Calamos Investments explained in early July. “As we’ve discussed in the past, convertibles vary in their levels of equity sensitivity and fixed-income sensitivity. The greater the equity sensitivity, the greater the convertible’s exposure to both the upside and downside of its underlying equities.”
This variation means that the term convertible bond describes a distinctly broad category rather than a uniform investment. Investors must judge the strength of the issuer, the conversion terms and the bond’s sensitivity to the underlying shares. A low coupon rate may be acceptable when the equity option is valuable, but that potential upside does not eliminate the risk of a credit loss.
Numerix recorded 96 global convertible-securities issues worth $84.6 billion in the second quarter of 2026, 67 percent more than a year earlier. The market-analytics firm also identified information technology as the largest issuing sector during the quarter, accounting for $34.4 billion across 31 transactions, with artificial intelligence (AI) in particular generating significant funding demand.
Convertibles allow AI companies to fund immediate spending while preserving cash and offering investors participation in expected future growth.
Indeed, all 10 of the quarter’s largest deals were attributable to AI infrastructure, semiconductors or data-centre expansion, all of which require substantial investments before generating revenue. Convertibles allow AI companies to fund immediate spending while preserving cash and offering investors participation in expected future growth.
Beyond funding AI companies, refinancing is another major source of convertibles issuance. Five- and six-year notes issued during the 2020–21 financing surge are now approaching maturity, creating a demand for replacement financing. Observing in January that “convertible notes issuances have been surging in the last few years to a market size of approximately $300 billion,” law firm Cleary Gottlieb stated that convertible-bond issuance “is expected to continue through 2026, driven by issuers looking to refinance existing convertible debt, particularly in vintages from the COVID era when converts issuance ticked up dramatically”.
Share-price volatility also helps explain the soaring appeal of convertible financing, with Numerix identifying elevated volatility in individual technology and AI shares as a distinct feature of the market in the second quarter (Q2). All else being equal, greater expected price fluctuations increase the value of an equity option because they boost the likelihood of a substantial payoff for the investor. Applied to convertible financing, a more valuable conversion option can support a lower coupon or a higher conversion premium.
The absence of a coupon rate, however, does not make borrowing free. onsemi’s May issuance, for instance, illustrates the distinction between the stated interest rate and the wider economic cost of issuing a convertible bond. “On May 11, 2026, the Company issued $1.5 billion aggregate principal amount of 0% Convertible Senior Notes due May 1, 2031…in a private offering,” it stated in its quarterly filing. “The Company received net proceeds of $1,472.9 million after deducting purchaser discounts and debt issuance and other financing costs. Concurrently with the issuance, the Company paid $351.6 million to enter into convertible note hedge transactions and received $281.0 million in proceeds from the sale of warrants.” The hedge and warrant transactions thus produced a net cash outlay of $70.6 million before tax effects.
The financing must, therefore, be assessed as a package. Its costs include issuance expenses, the net price of the hedge and warrants, and the value of the conversion rights granted to investors. Should conversion remain unattractive, onsemi would still have to repay the principal at maturity. While a zero coupon describes the scheduled interest payment, it does not measure the company’s total economic cost.
The convertible bargain can also break down for both sides. For investors, the “bond floor” is an estimate of what the security’s debt component is worth rather than a guarantee that its market price cannot fall. If either the issuer’s shares decline, its credit quality deteriorates, or market interest rates rise, both the conversion option and the bond component can lose value. Limited trading liquidity may further amplify the decline.
Nicolas Crémieux warned that rapid issuance is affecting credit quality. “As issuance volumes rise, the quality of some issuers at the margin is beginning to deteriorate. Maintaining credit discipline and avoiding the temptation to reach for yield in weaker names remains a priority,” Mirabaud Asset Management’s convertible bond portfolio manager confirmed in a report published on July 2.
Issuers face the opposite risk. A strong increase in their share prices may lead to conversion and shareholder dilution, while weak share prices leave the debt outstanding, thus requiring repayment or refinancing at maturity. Contractual call provisions allow an issuer to redeem the bonds under specified conditions, sometimes encouraging investors to convert earlier and limiting further gains.
Market classifications also require care. Mandatory convertible preferred shares, including Alphabet’s record $19.3-billion transaction, automatically convert into equity and do not provide the same conventional repayment choice as an ordinary convertible bond. Headline figures combining both structures can thus make both the market for conventional convertible debt and the amount of financing carrying a debt-repayment option appear larger than is actually the case.