DEFINITION of Market Conversion Price
An investor's effective cost to purchase common stock when it is purchased in the form of a convertible security and the investor then exercises the security's conversion option. The market conversion price is calculated by dividing the convertible security's market price by the convertible security's conversion ratio.
Examples of convertible securities include convertible bonds, which can be exchanged for shares of a company's stock, and convertible preferred stock, which can be exchanged for shares of common stock. Collectively, this category of investments is known as "convertibles."
BREAKING DOWN Market Conversion Price
When the investor purchases the 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 will initially value the security for more than the security's current market value, but as market conditions change, so can this relationship.
As an example, suppose an investor owns convertible bonds in The World’s Best Widget Company, and he or she decides convert those bonds into stock shares of the company. Assuming that the bond’s ratio at the time is 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, achieved by dividing the $500 bond ratio, by the 10 common shares ($500/10).
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. And 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. But it is ultimately up to each investor, to strategically determine if and when to follow through on the option to exchange his or security for common stock, or to hold onto it until it reaches its full maturity.
But while attractive conversion prices may motivate many investors to exercise their options, doing so may dilute the value of a company's shares, which is a potential downside for existing stockholders, who should therefore always be cognizant of the convertible securities offered by companies they invest in.
From the perspective of the holding companies, the conversion prices of convertible securities helps them to assess the value of their stock, and determine the levels of financing that may possibly be raised, down the line. Furthermore, the conversion price may influence the issuance of future stock shares, and affect the price of those securities.