What Is the Market Conversion Price?
The market conversion price is the amount investors pay for a share when exercising their option to exchange convertible securities, typically convertible bonds or convertible preferred shares, into common stock. The market conversion price is calculated by dividing the convertible security's market price by its conversion ratio.
- The market conversion price is the amount investors pay for a share when exercising their option to exchange convertible securities into common stock.
- It is calculated by dividing the convertible security's market price by its conversion ratio—the number of common shares a convertible security can be converted into.
- The conversion ratio will initially value the security at more than its current market value, making conversion desirable only if a company's common shares rise significantly.
- Attractive conversion prices will likely motivate investors to exercise their options, diluting the value of a company's shares.
How the Market Conversion Price Works
When an investor purchases a convertible security, it will often be associated with a conversion ratio that predetermines the number of shares the investor will receive by choosing to convert the security. The conversion ratio, which for convertible bonds can be found in the bond indenture or for convertible preferred shares in the security prospectus, will initially value the security at more than its current market value, making conversion desirable only if a company's common shares rise significantly.
The conversion ratio determines how many shares of stock investors can get when converting securities—for example, a 5:1 ratio means that one bond would convert to five shares of common stock.
Ultimately, it is up to each investor to strategically determine if and when to follow through on the option to exchange his or her security for common stock, or to hold onto it until it reaches its full maturity. If the stock trades below the market conversion price, converting the security into common shares makes little sense. Only when the shares rise above the market conversion price is it potentially advantageous to cash in on the convertible option.
Example of a Market Conversion Price
Suppose an investor owns convertible bonds in The World’s Best Widget Company, and he or she decides to convert those bonds into stock shares of the company.
Assuming that the bond’s ratio at the time of the conversion is $500, and its conversion ratio is 10 shares per bond, then the market conversion price for the shares would be $50 per share. This is calculated by dividing the $500 bond ratio, by the 10 common shares ($500/10).
Advantages of the Market Conversion Price
Convertible securities are frequently sought by investors looking for short-term fixed income, who also believe that the issuer’s price for shares of stock is likely to spike in the future.
Because fluctuations in the convertible security's market price affect the market conversion price, convertible security holders can profit in situations where market conversion prices are lower than the current market price of those shares.
Meanwhile, from the perspective of the holding companies, the conversion prices of convertible securities help them to assess the value of their stock and determine the levels of financing that may possibly be raised, down the line.
The conversion price may influence the issuance of future stock shares, and affect the price of those securities. Company executives consult with various experts before determining the price. A lot of focus is placed on striking a balance between making the convertible securities appealing to potential investors, while also being fair to existing equity shareholders.
Attractive conversion prices may motivate many investors to exercise their options, although doing so could dilute the value of a company's shares, impacting existing stockholders. As a result, potential investors should always be cognizant of the convertible securities offered by companies they invest in.