Conversion Ratio

What is the 'Conversion Ratio'

The conversion ratio is the number of common shares received at the time of conversion for each convertible security . The higher the ratio, the higher the number of common shares exchanged per convertible security . The conversion ratio is determined at the time the convertible security is issued and has an impact on the relative price of the security.

Conversion Ratio

BREAKING DOWN 'Conversion Ratio'

There are two main types of capital fundraising tools: debt and equity. Debt must be paid back, but it is often cheaper to raise capital by issuing debt than it is equity due to tax considerations. Equity does not need to be paid back, which is helpful in difficult times or when earnings growth is negative. Raising capital with equity relinquishes ownership and ownership comes with voting rights. Even though equity takes a back seat to debt in terms of credit, shareholders benefit from share price appreciation when earnings growth is strong. The interest rate paid to debt holders stays the same regardless of earnings performance.

Each fundraising method has its advantages and disadvantages. One way investors and companies take advantage of both worlds is with the use of a hybrid security called a convertible. The conversion ratio tells investors how many common shares they get in exchange for a convertible bond or stock. The company sets the conversion ratio and date at the time of issue.

Convertible Debt Example

Convertible debt is a debt hybrid product with an embedded option that allows the holder to convert the debt into equity at some point in the future. The registration statement tells investors the number of shares to be granted. For example, one bond that can be converted to 20 shares of common stock has a 20 to 1 conversion ratio. The conversion ratio can also be found by taking the par value of the bond, which is generally $1,000, and dividing it by the share price. A stock trading for $40 has a conversion ratio equal to $1,000 divided by $40, or 25.

Convertible Preferreds

Convertible stock is a hybrid equity product. Preferred stockholders receive a dividend like a bond and rank higher than equity in case of liquidation, but they have no voting rights. Converting to stock gives the preferred shareholder voting rights and allows her to benefit from share price appreciation. For example, if a company issues convertible preferred with a 5% dividend and a conversion ratio of five, it means the investor gets five common shares for each share of preferred shares. If the preferred stock is trading at $100, the conversion break-even price on common shares can be determined by dividing the price by the conversion ratio, which is $20.

In both instances, the conversion ratio drives the price of the convertible.

RELATED TERMS
  1. Conversion Price

    The price per share at which a convertible security, such as ...
  2. Market Conversion Price

    An investor's effective cost to purchase common stock when it ...
  3. Convertible Preferred Stock

    Preferred stock that includes an option for the holder to convert ...
  4. Conversion Parity Price

    The price paid for a share of stock purchased by exercising the ...
  5. Conversion Value

    The financial worth of the securities obtained by exchanging ...
  6. Convertible Security

    An investment that can be changed into another form. The most ...
Related Articles
  1. Managing Wealth

    Introduction To Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
  2. Managing Wealth

    The Wonders Of Convertible Bonds

    Ever wondered what exactly a convertible bond does? Read the features of a convertible bond and learn how important the conversion factor is to you as an investor.
  3. ETFs & Mutual Funds

    Why Include Convertible Securities in Your Portfolio

    What are convertible securities and why you should include them in your portfolio.
  4. Managing Wealth

    Convertible Bonds: Pros And Cons For Companies And Investors

    Find out why businesses choose this type of financing and what effect this has on investors.
  5. Managing Wealth

    Convertible Bonds: An Introduction

    Find out about the nuts and bolts, pros and cons of investing in bonds.
  6. Investing

    What is Convertible Preferred Stock?

    Convertible preferred stock is preferred stock that can be converted into common stock as of a predetermined date at a specified ratio.
  7. Financial Advisor

    Worried About Stocks? Try on Convertibles

    Convertibles are a good hedge against equity market risk (if you're o.k. with losing a bit of upside potential).
  8. ETFs & Mutual Funds

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  9. Investing

    Is Now the Time for Convertible Bonds?

    Convertible bonds offer a competitive rate of return in what is a very tough market right now. Here's how they work.
  10. Trading

    The Mandatory Convertible: A "Must Have" For Your Portfolio?

    Mandatory convertibles are a little understood security with some distinct advantages. Find out if they are right for you.
RELATED FAQS
  1. What is a 'busted' convertible bond?

    Learn about busted convertible bonds; these are hybrid securities with conversion prices significantly higher than the market ... Read Answer >>
  2. Why would a corporation issue convertible bonds?

    Discover how corporations issue convertible bonds to take advantage of much lower interest rates as a result of a conversion ... Read Answer >>
  3. Why do some investors prefer convertible over “straight” bonds?

  4. Do convertible bonds have voting rights?

    Convertible bonds usually have no voting rights until they are converted. Even after conversion, they may not be granted ... Read Answer >>
  5. Where does the stock come from when convertible bonds are converted to stock?

    First, let's define convertible bonds. A unique combination of debt and equity, they provide investors with the chance to ... Read Answer >>
  6. What is a Chinese hedge?

    A Chinese Hedge is a form of arbitrage by which an investor shorts a convertible bond and buys the underlying common stock. ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center