The term conversion value refers to the financial worth of the securities obtained by exchanging a convertible security for its underlying assets. Convertibles are a category of financial instruments, such as convertible bonds and preferred shares, which can be exchanged for an underlying asset, such as common stock. Conversion value is calculated by multiplying the common stock price by the conversion ratio.
Breaking Down Conversion Value
A convertible security that is trading at a price above its conversion value is said to have a conversion premium. This makes the security valuable and desirable. A convertible security is considered "busted" when it is trading at a price far below its conversion value. If the price of the underlying security falls too far below the conversion value, the convertible security is said to have reached its floor.
The conversion value might also be called the market conversion price or parity value. As with types of investments such as stock options, a key objective with a convertible security is to hold onto it until the market price is higher than the conversion value, thus generating profit through the conversion and later sale.
How Conversion Value Is Determined
Understanding what the floor value is for convertible bonds can help the bond holder determine when the underlying asset is worth converting. This includes knowing the face value for the bond. For instance, typically, when a convertible bond reaches maturity, the holder gets the face-value principal payment that is equal to the amount they initially paid for the bond. The bond has also been generating interest over the course of the maturity period.
The floor value can be determined even before the bond reaches maturity through a calculation. Adding the principal payment to the interest payments, or bond yield, that have been received and are expected until it reaches maturity will result in the floor value. That is the figure that can be used for comparison against the conversion value to assess the worth of the securities.
In many examples, it is not profitable to exercise an option to convert, if allowed, before a convertible security matures. There may be stipulations that require the security to be held until it reaches a certain conversion price. It might be necessary for the issuers of convertible notes to bifurcate, or divide the fair value or price of a convertible bond between fair values for the conversion aspect and for the straight debt, which cannot be converted.