What is the 'Conversion Price'

The conversion price is the price per share at which a convertible security, such as corporate bonds or preferred shares, can be converted into common stock. The conversion price is calculated from the conversion ratio and determined when the convertible security is issued. The conversion ratio can be found in the bond indenture (in the case of convertible bonds) or in the security prospectus (in the case of convertible preferred shares).

BREAKING DOWN 'Conversion Price'

The conversion price comes into play when companies are trying to raise capital. They can raise capital through either debt or equity. Debt must be paid back to lenders, but it tends to cost less than equity due to the tax advantages associated with paying interest. Equity may cost more to raise than debt, but it does not need to be paid back. From the investor's perspective, bonds are safer, but they have a limited return. Equity provides an opportunity for share price appreciation, but no protection in case of company default. Convertible bonds, preferreds and debentures provide a hybrid option for companies and investors. Companies are willing to pay a little more, and investors are willing to accept a little less, for the embedded conversion option that allows holders of convertible securities to convert to common shares if the price of common shares reaches a certain price. This price is referred to as the conversion price.

Conversion Price

The conversion price is essential in determining the number of shares to be received upon conversion. If shares never close above the conversion price, the convertible bond is never converted to common shares. Usually, the conversion price is set at a significant amount higher than the current price of the common stock to make conversion desirable only if a company's common shares experience a significant increase in value. To determine the conversion price, you need to obtain the conversion ratio. The conversion ratio is set by management before the convertibles are issued.

Example Calculation

For example, a bond has a conversion ratio of 5, which means the investor can trade one bond for five shares of common stock. The conversion price of the convertible security is the price of the bond divided by the conversion ratio. If the bonds value at the time of conversion is $950, the conversion price is calculated by dividing $950 by 5, or $190. If the conversion ratio is 10, the conversion price drops to $95. A higher conversion ratio results in a lower conversion price, just as a lower conversion ratio results in a higher conversion price.

RELATED TERMS
  1. Market Conversion Price

    The cost of converting a convertible security into a common stock, ...
  2. Conversion

    A conversion is the exchange of a convertible type of asset into ...
  3. Conversion Value

    The financial worth of a convertible security – if its call option ...
  4. Adjustment in Conversion Terms

    A term used to describe the adjustment made to a convertible ...
  5. Mandatory Convertible

    A mandatory convertible is a type of convertible bond that has ...
  6. Busted Convertible Security

    A busted convertible security is a convertible bond where the ...
Related Articles
  1. Investing

    Introduction to Convertible Preferred Shares

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

    Roth Conversions Must Now Be Used Wisely

    Completing a Roth IRA conversion is a solid strategy, if done correctly and at the right time, especially now that recharacterizations are not allowed.
  3. Investing

    Leverage Your Returns With A Convertible Hedge

    Find out how you can maintain your income stream by using this type of bond strategy.
  4. Managing Wealth

    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.
  5. Investing

    3 Best High-Yielding Convertible Bond Mutual Funds (LACFX, FACVX)

    LACFX,FACVX,VCVSX: Learn about three of the highest-yielding options available.
  6. Investing

    The Top 6 Convertible Bond Funds for 2016

    Take a look at convertible bond mutual funds that are well-positioned heading into 2016, and why investors might consider a convertible fund portfolio.
  7. Investing

    Can a Bond ETF Work in a Rising Rate Environment?

    The CWB Convertible Securities ETF could be the perfect solution for a rising rate environment.
RELATED FAQS
  1. What are 'death spiral' convertible bonds?

    Conventional convertible bonds give the bondholder the right to exchange the bond for a certain amount of the issuer's common ... Read Answer >>
  2. 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 >>
Trading Center