A security that has the potential to dilute its issuer's earnings per share. For example, a convertible bond can be exchange for so many shares of common stock. If it is exchanged, then the earnings per common share are diluted because there are now more common shares by which to divide earnings. For that reason, a convertible bond is a residual security.
A security with the potential for diluting earnings per share. A convertible bond is a residual security because conversion of the bond by an investor will result in more shares of common stock outstanding and a reduction in earnings per share.