What Is Conversion Value?
The term conversion value alludes to the financial worth of the securities got by trading a convertible security for its underlying assets. Convertibles are a category of financial instruments, for example, convertible bonds and preferred shares, which can be traded for an underlying asset, like common stock.
Conversion value is calculated by duplicating the common stock price by the conversion ratio.
Understanding Conversion Value
Likewise with types of investments, for example, stock options, a key objective with a convertible security is to hold onto it until the market price is higher than the conversion value, in this manner generating profit through the conversion and later sale of the common stock received.
The conversion value is closely connected with the market conversion price or parity value, which are utilized to recognize break-even values at a specific stock price. The conversion value, then again, works out what the net value would be to a conversion done right now at current market prices in the stock.
A convertible security that is trading at a price over its conversion value is said to have a conversion premium. This makes the security significant and attractive. A convertible security is thought of "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 arrived at its floor.
How Conversion Value Is Determined
Understanding what the floor value is for convertible bonds can assist the bond holder with determining when the underlying asset is worth changing over. This incorporates realizing the face value for the bond. For example, typically, when a convertible bond arrives at maturity, the holder gets the face-value principal payment that is equivalent to the amount they initially paid for the bond. The bond has likewise been generating interest throughout the maturity period.
The floor value can be determined even before the bond arrives at maturity through a calculation. Adding the principal payment to the interest payments, or bond yield, that have been received and are expected until it arrives at maturity will bring about the floor value. That is the figure that can be utilized for comparison against the conversion value to evaluate the worth of the securities.
In numerous models, it isn't profitable to exercise an option to change over, whenever permitted, before a convertible security develops. There might be expectations that require the security to be held until it arrives at a certain conversion price. It very well may be vital for the issuers of convertible notes to bifurcate, or split the fair value or price of a convertible bond between fair values for the conversion perspective and for the straight debt, which can't be changed over.
Illustration of Conversion Value
Assume that investor claims convertible bonds in XYZ Corp., and chooses to use the call option to change over those bonds into common shares of the company.
Accepting that the bond's conversion ratio is 50 shares for each bond, and the bond shares of XYZ stock are trading at $20, then the conversion value of one bond would be $1,000 (for example 50 x $20)
- Conversion value is the amount an investor would received in the event that a convertible security is changed into common stock.
- Conversion value calculations are helpful in determining break-even or floor values engaged with holding convertible securities.
- This value is shown up at by increasing the conversion ratio (the number of shares that received per bond) by the market price of the common stock.