Convertible Bonds Explained — Why a 0% Coupon Bond Can Still Attract Buyers

A Bond With a 0% Coupon That People Still Buy

Every so often a company issues a bond at an interest rate close to zero — sometimes literally zero — and investors still line up to buy it. On the surface that makes no sense: nobody lends money for free. The reason it works is that the bond isn't really paying nothing. Instead of cash interest, the holder gets something the market often values more: the right to convert that debt into shares of the company at a fixed price. That instrument is a convertible bond (CB). This lesson works through why CBs can carry such low coupons, and why the "refixing" clause built in to protect CB holders so often becomes a drag on the stock itself.

What a Convertible Bond Actually Is — A Bond With a Call Option Attached

A convertible bond has two components stacked together. The base layer is an ordinary bond: the company borrows money and promises to repay principal plus a stated coupon at maturity. Layered on top is a call option: the right, exercisable any time before maturity, to convert that bond into shares of the issuer at a preset price known as the conversion price. Buying a CB means buying both pieces as a single package.

That embedded option is what explains the low coupon. If a company issued a plain bond, it would have to pay whatever coupon its credit rating and prevailing rates demand. Because the conversion right itself has value — it's essentially a call option on the stock, and options are worth more the more volatile and the more upside-prone the underlying looks — investors are willing to accept a lower cash coupon in exchange for that option. Zero-coupon CBs aren't unusual: if an investor believes the stock is likely to rise, they'll happily give up nearly all the interest income in exchange for the right to convert into shares once the price runs past the conversion price.

Why Companies Choose CBs Over Straight Debt or a Stock Offering

Companies generally have three broad ways to raise money: pure debt (bank loans, straight corporate bonds), pure equity (a rights offering), and hybrids like the CB that sit between the two. CBs offer a few concrete advantages over either pure option.

First, the coupon is cheaper. This matters most for smaller or growth-stage companies — the kind common on Korea's KOSDAQ exchange — that either carry a weak credit rating or aren't yet profitable enough to issue straight bonds at an acceptable rate. The embedded option absorbs much of that cost. Second, a CB avoids immediate dilution. A rights offering puts new shares into the market and increases the share count the moment it closes; a CB changes nothing about shares outstanding until and unless the conversion right is actually exercised. Third, if management believes the current share price undersells the company's real value, a CB effectively lets it raise capital now while implicitly pricing future equity at the (higher) conversion price rather than selling shares cheaply today. Together, these make CBs a comparatively low-friction financing tool for companies whose balance sheets aren't yet rock-solid or whose stock is trading under pressure.

Refixing — Why the Conversion Price Can Fall

At the center of every CB sits one number: the conversion price. Say an investor buys a CB with a conversion price of ₩10,000 — they can convert the bond into shares at that price. If the stock then drifts down to ₩8,000, then ₩6,000, the conversion right becomes effectively worthless: nobody converts at ₩10,000 when the stock trades for ₩6,000 on the open market.

To protect CB holders against exactly this scenario, issuance agreements commonly include a refixing clause: if the stock falls by a specified amount after issuance, the conversion price resets downward according to a formula set in the contract. In Korea, this downward adjustment is typically bounded by a floor — a level often cited around 70% of the original conversion price, below which the price cannot be reset further. The precise floor, and the conditions under which a lower floor is even allowed, are set by regulation and by the specific issuance contract, and both have been amended over time — so anyone evaluating a real CB should check the actual terms disclosed for that issue rather than assume a fixed number.

Why Refixing Puts Pressure on the Stock Before Conversion Even Happens

This is where CBs create a distinctive kind of pressure on a stock. A lower conversion price after refixing means the same face value of bonds converts into more shares than originally planned. A ₩10 billion CB issued at a ₩10,000 conversion price converts into 1 million shares; refixed down to ₩7,000, that same ₩10 billion converts into roughly 1.43 million shares instead — meaningfully more dilution for existing shareholders than the original terms implied.

The problem is that the market doesn't wait for conversion to actually happen before pricing this in. As a stock declines toward a level where refixing looks likely, participants start pricing in the expectation of a lower conversion price and a larger eventual share count — and that expectation itself becomes selling pressure, ahead of any bond actually being converted. If CB holders then convert at the newly lowered price and sell the resulting shares promptly to lock in the arbitrage, a self-reinforcing pattern can emerge: falling price → refixing → expectation of more shares outstanding → further pressure on the price. This is why stocks with a large outstanding CB balance — especially CBs still eligible for further refixing — are often observed to have their rebounds capped by this overhanging potential share count.

CB vs. BW vs. EB — Three Similar-Looking Instruments With Different Mechanics

CBs are frequently confused with bonds with warrants (BW). Both attach an equity-related right to a bond, but the nature of that right differs. Exercising a CB's conversion right retires the bond — it converts into shares and the debt disappears. A BW keeps the bond and the warrant as two legally separate rights: exercising the warrant requires paying additional cash to buy new shares, and the underlying bond survives, continuing to pay coupons and principal through maturity regardless of whether the warrant is exercised. Warrants that can be detached and traded separately from the bond make it a "detachable BW"; ones that stay bundled together are "non-detachable BW."

A third instrument worth knowing is the exchangeable bond (EB). Where CBs and BWs create brand-new shares of the issuer, an EB is exchangeable into shares the issuer already owns in a different company — typically treasury shares or a stake in an affiliate. Because no new shares are created, an EB doesn't increase the issuing company's own share count — the key difference from both CB and BW.

	Convertible bond (CB)	Bond with warrant (BW)	Exchangeable bond (EB)
Bond status after right is exercised	Extinguished (converts to shares)	Survives (only the warrant is exercised)	Depends on structure
Extra cash required to exercise	No	Yes (warrant exercise requires separate payment)	No
New shares created	Yes	Yes	No (exchanged for shares already held)
Dilutes the issuer's share count	Yes	Yes	No

Why Retail Investors Treat CB Announcements With Caution

Markets generally greet CB issuance announcements with some skepticism, and dilution and refixing overhang aren't the only reasons.

One is a history of low-priced CB abuse. In cases that have drawn regulatory attention in Korea, controlling shareholders or related parties acquired CBs at conversion prices well below prevailing market levels, then converted later to expand their stake cheaply or capture the spread as a gain — at the expense of minority shareholders who received no equivalent opportunity. Repeated cases of this kind pushed regulators to tighten the rules over time: capping how much of a call option (the right to buy back the CB from the issuer) can be allocated to related parties, and requiring a shareholders' special resolution — not just a provision buried in the articles of incorporation — before a privately placed CB can set its refixing floor below the standard level. The specifics of these rules, and their effective dates, have continued to be revised, so the terms that actually apply to a given CB depend on when it was issued.

Another factor is the put option, formally the early redemption right. Many CBs give the holder the right to demand early repayment from the issuer after a specified date. If the stock stays well below the conversion price for long enough, CB holders are more likely to exercise this put rather than convert — demanding their principal and accrued interest back in cash instead. For the issuer, that can mean an unplanned, lump-sum cash outflow at a time not of its choosing. A company without ample liquidity can find that put exercise turns into a genuine cash crunch, which is why checking a company's outstanding CB balance and the dates its puts become exercisable matters when assessing risk.

CB Issuance Isn't Automatically Bad News

Treating every CB announcement as an automatic red flag oversimplifies things. When the stated purpose is funding new capacity or expanding a promising business line — spending expected to translate into future earnings growth — markets sometimes react neutrally or even positively. When the stated purpose is closer to "working capital" — plugging a near-term cash shortfall — it tends to read as a signal that the company couldn't raise funds on better terms elsewhere, and the reaction leans negative. The more useful habit, rather than assuming a fixed verdict, is to check the stated use of proceeds, how large the issuance is relative to existing market cap and share count, the conversion price and refixing terms, and when any put option becomes exercisable.

Takeaways

• A convertible bond bundles an ordinary bond with a call option to convert into shares at a fixed conversion price — that option's value is what allows CBs to carry unusually low, sometimes zero, coupons.
• Refixing protects CB holders by lowering the conversion price when the stock falls, but it also means more shares get created on conversion, diluting existing shareholders further — and markets tend to price in that expected dilution well before conversion actually happens.
• A CB's bond disappears on conversion; a BW's bond survives while only the warrant is exercised separately; an EB creates no new shares at all, since it exchanges for stock the issuer already holds.
• Past cases of low-priced CBs used to expand controlling stakes, plus the liquidity risk from early-redemption put options, are real risks to check for on any CB-heavy issuer.
• Reading a CB announcement well means checking the use of proceeds, issuance size relative to the float, the conversion price and refixing terms, and the put option's timeline — not assuming the news is automatically good or bad.

FAQ

Does a CB announcement always push the stock down?

Not necessarily. Markets often react negatively because they price in potential dilution and refixing overhang in advance, but if the stated use of proceeds is a clear growth investment and the issuance size is modest relative to the company, the reaction can be muted or even positive.

Is the conversion price fixed forever once it's set?

No. If the issuance terms include a refixing clause, the conversion price can be adjusted downward within the contracted formula and floor when the stock falls. Some terms also require it to be adjusted back upward if the stock later recovers. The exact mechanics vary by issue, so check the specific terms disclosed for that CB.

Can CB investors lose money?

Yes. A convertible bond is still ultimately a claim on the issuer's creditworthiness, so if the company defaults or goes bankrupt, CB holders can fail to recover their principal. The conversion right and any put option give the holder favorable choices, but neither one guarantees the issuer's ability to actually pay.

⚠️ This article is for informational purposes only and is not investment advice. You are solely responsible for your own investment decisions and their outcomes.