Parity

What is 'Parity'

Parity refers to two things being equal to each other. The term "par value" for a bond is similar to parity. Parity can also refer to two securities having equal value, such as a convertible bond and the value of the stock if the bondholder chooses to convert into common stock.

In an exchange market, parity occurs when all brokers bidding for the same security have equal standing due to identical bids. When parity occurs, the market must determine which bidding broker will obtain the security by alternative means. Therefore, the winning bid is typically awarded by random draw. In foreign exchange markets, currencies are at parity when the exchange rate relationship is exactly one to one.

BREAKING DOWN 'Parity'

Many investors have to make decisions about the value of two different investments. A convertible bond, for example, allows the investor to own a bond and earn a stated rate of interest or convert the bond into a fixed number of shares of common stock. Assume, for example, that an investor can own a $1,000 corporate bond with a market price of $1,200 or convert the bond into 100 shares of common stock. If the stock’s market price is $12, the market value of the 100 shares of stock is also $1,200. As a result, the bond and the stock are at parity.

Factoring in Options

The term "parity" also applies to stock options. One call option, for example, allows the owner to buy 100 shares of stock at a specific price (strike price) for a stated period of time. Assume that an investor owns a $50 call option that expires on September 30. The investor has the right to buy 100 shares of stock at $50 per share until the expiration date in September.

The intrinsic value of an option is the difference between the strike price and the market price of the stock. If the stock's market price is $60 per share, for example, the option's intrinsic value is $10 per share. If the market price of the call option is also $10 per share, the option is trading at parity.

How Currency Trading Defines Parity

Companies based in the United States that have operations in foreign countries must convert U.S. dollars into other currencies. If a U.S. firm does business in France, for example, the company can convert U.S. dollars into euros and sends those euros to fund its French business operations. If the exchange rate is $1 to €1, the currencies are at parity.

Examples of Parity in Asset Management

Risk parity is an asset management process that evaluates risk based on asset classes rather than allocation of capital. Tradition asset allocation strategy divides assets between stocks, bonds and cash. The goal is to provide diversify and reduce risk by using these the types of investments. Risk parity, on the other hand, allocates dollars based on four components: equities, credit, interest rates and commodities. Risk parity attempts to reduce risk and increase investment returns.

RELATED TERMS
  1. Conversion Parity Price

    The price paid for a share of stock purchased by exercising the ...
  2. Risk Parity

    A portfolio allocation strategy based on targeting risk levels ...
  3. Interest Rate Parity

    A theory in which the interest rate differential between two ...
  4. Uncovered Interest Rate Parity ...

    A parity condition stating that the difference in interest rates ...
  5. Relative Purchase Power Parity

    An expansion of the purchase power parity theory, which suggests ...
  6. Convertibles

    Securities, usually bonds or preferred shares, that can be converted ...
Related Articles
  1. Investing Basics

    Understanding Risk Parity

    Risk parity is an investment strategy that focuses on the allocation of risk across a portfolio.
  2. Options & Futures

    What is Put-Call Parity?

    Put-call parity describes the relationship that must exist between European put and call options with the same expiration date and strike prices.
  3. Trading Strategies

    How to Create a Risk Parity Portfolio

    Learn about how risk parity uses leverage to create equal exposure to risk among different asset classes in portfolio construction.
  4. Forex Education

    Explaining Uncovered Interest Rate Parity

    Uncovered interest rate parity is when the difference in interest rates between two nations is equal to the expected change in exchange rates.
  5. Bonds & Fixed Income

    Convertible Bonds: An Introduction

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

    20 Investments: Convertible Security

    What Is It? A convertible, sometimes called a CV, is either a convertible bond or a preferred stock convertible. A convertible bond is a bond that can be converted into the company's common stock. ...
  7. Investing

    What You Should Know About Convertible Bonds

    As investors continue to seek yield in the current market, it's now a good time to bring up an often overlooked asset class—the convertible bond.
  8. Financial Advisors

    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).
  9. Investing

    Why Include Convertible Securities in Your Portfolio

    What are convertible securities and why you should include them in your portfolio.
  10. Options & Futures

    Using Interest Rate Parity To Trade Forex

    Learn the basics of forward exchange rates and hedging strategies to understand interest rate parity.
RELATED FAQS
  1. Is risk parity a safe investment strategy?

    Learn how risk parity funds won't blow away the market, but will grow steadily over time by using the time-tested strategies ... Read Answer >>
  2. What is a convertible bond?

    A convertible bond is a bond issued by a corporation that, unlike a regular bond, gives the bondholder the option to trade ... Read Answer >>
  3. How is convertible bond valuation different than traditional bond valuation?

    Read about bond valuation, particularly the differences between how a traditional bond is valued and how a convertible bond ... Read Answer >>
  4. 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 >>
  5. How do I use a premium put convertible?

    Holders of convertible bonds face all the pitfalls that traditional bondholders face - liquidity risk, interest rate risk ... Read Answer >>
  6. What does it mean when an investor moves a bond to equity?

Hot Definitions
  1. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  2. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  3. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  4. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  5. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center