As the name suggests, convertible bonds allow the owner the option to convert the bonds into a fixed number of shares of common stock. Innovative Energy LLC is a start-up company that just raised $100,000 to conduct a third-party feasibility study on its business model. the company agreed to treat the $100,000 investment as debt at 10% interest rate; however, the investor has the right to exchange the debt for common stock during the company's next financing round. Which of the following terms best describes the $100,000 investment?

Convertible bond
Warrant

The $100,000 investment is a convertible bond.

Explanation:

A convertible bond is an interest-bearing or non-interest bearing loan that a public limited company can borrow from an investor. The terms of the loan will determine whether the investor has the right, at the end of the loan period, to convert all or part of the loan amount into the company's shares according to a predetermined conversion ratio.

The conversion ratio (how many shares a lender receives for a given amount of loan) may be fixed or agreed upon based on the circumstances of the exchange, such as the financial ratios calculated from the company's financial statements. The exchange may take place at a pre-determined time or in certain circumstances. The convertible bond may be targeted to a specific target group so that the subscription right for the shares cannot be transferred.

The convertible bond combines the interest yield of the loan with the option of either repaying the principal loan or taking advantage of the increase in the value of the share. It is therefore an intermediate form of equity and debt. Convertible bonds are a popular form of financing, for example, in situations where a small growth company is being financed by venture capitalists. The option included in the loan to convert the growth company loan into equity at a later date may be extremely valuable to the investor. For this reason, a growth company does not usually have to pay the same interest on a convertible bond as on another loan.

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