Conversion Price - Explained
What is a Conversion Price?
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Table of ContentsWhat is a Conversion Price?How does a Conversion Price Work? Why is the Conversion Price Important? Example CalculationAcademic Research on Conversion Price
What is a Conversion Price?
The conversion price refers to the price at which a convertible security is converted into common stock. The price per share at which each unit of a convertible security is changed is the conversion price. Examples of convertible securities are preferred shares or corporate bonds. The conversion price of such securities can be known when they are issued and through the conversion ratio. To calculate the conversion ratio; the price par value of the convertible security will be divided by the conversion price of the stock. Oftentimes, conversion ratios are contained in bond indenture or security prospectus.
How does a Conversion Price Work?
Generally, companies, when in need of capital raise capital through debt or equity. One of the ways to raise capital using equity is through the conversion of convertible securities into common stock. Conversion price is necessary at this time. Some companies prefer raising capital through equity than debt, this is because debts must be paid back and paid with interest but equity requires no pay back. Conversion Price is needed when an exchange of convertible security for common stock is about to take place. Holders of convertible securities are allowed to change the securities into common stock at a price par value. The price agreed upon for the exchange is the conversion price.
Why is the Conversion Price Important?
When an exchange of convertible securities to common shares is to take place, there must be a conversion price realized through the conversion ratio. The conversion price is often a little higher than the current price of the common stock. This is to make the exchange attractive to investors, at this stage, a significant increase in the value of common shares becomes the compelling point for investors. The conversion price determines the number of shares investors can receive when changing their convertible security. Also, before a conversion price can be set, the conversion ratio (set by the company's management) must first be obtained.
During conversion, the conversion price is realized by; Dividing the price of the bond by the conversion ratio. If a corporate bond has a conversion ratio of 3, what it tells investors or shareholders is that they can change one bond for 3 common shares. If the current value of the preferred bond being converted is $600, hence, the price of the bond would be divided by the conversion ratio to get the conversion price. Price of the bond / conversion ratio = $600/3 = $200.
Academic Research on Conversion Price