Conversion Price

What is the Conversion Price?

The conversion price is the price per share at which a convertible security, like corporate bonds or preferred shares, can be changed over into common stock. The conversion price is set when the conversion ratio is chosen for a convertible security. The conversion ratio can be found in the bond indenture (on account of convertible bonds) or in the security prospectus (on account of convertible preferred shares).

Understanding Conversion Price

The conversion price becomes possibly the most important factor when companies are attempting to raise capital. They can raise capital through one or the other debt or equity. Debt must be paid back to lenders, yet it will in general cost not as much as equity due to the tax benefits associated with paying interest. Equity might cost more to raise than debt, however it needn't bother with to be paid back.

According to the investor's point of view, bonds are more secure, yet they have a limited return. Equity gives an opportunity to share price appreciation, yet no protection in case of company default. Convertible bonds, preferreds and debentures give a hybrid option to companies and investors. Companies will pay somewhat more, and investors will acknowledge somewhat less, for the embedded conversion option that permits holders of convertible securities to switch over completely to common shares assuming the price of common shares arrives at the conversion price.

The Importance of the Conversion Price

The conversion price is part of deciding the number of shares to be received upon conversion. In the event that shares never close over the conversion price, the convertible bond is never switched over completely to common shares. Generally, the conversion price is set at a huge amount higher than the current price of the common stock to make conversion helpful provided that a company's common shares experience a critical increase in value. The conversion price is set by management as part of the conversion ratio before the convertibles are issued to the public. The conversion ratio is the par value of the convertible security separated by the conversion price.

The most effective method to Calculate the Conversion Price

For instance, a bond has a conversion ratio of 5, and that 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 separated by the conversion ratio. Assuming that the bonds par value is $1000, the conversion price is calculated by separating $1000 by 5, or $200. On the off chance that the conversion ratio is 10, the conversion price drops to $100. So the market price needs to get up to speed to the conversion price for the security to be changed over. A higher conversion ratio brings about a lower conversion price, just as a lower conversion ratio brings about a higher conversion price.