Conversion price

Definition

The conversion price is the predetermined price at which a convertible security, such as a bond or preferred stock, can be converted into a company's common equity. This price is critical as it determines how many shares an investor will receive upon conversion and reflects the issuer's expectations regarding future equity performance.

5 Must Know Facts For Your Next Test

1. The conversion price is usually set at a premium to the current market price of the underlying stock at the time the convertible security is issued.
2. When the market price of the underlying stock exceeds the conversion price, it becomes financially advantageous for investors to convert their securities into shares.
3. Changes in the company's stock performance can significantly impact investor decisions related to converting securities based on the conversion price.
4. The conversion price is typically fixed at issuance but may be subject to adjustments due to stock splits, dividends, or other corporate actions.
5. Investors should carefully assess the conversion price in relation to future growth prospects and market conditions when considering convertible securities.

Review Questions

• How does the conversion price impact an investor's decision to convert their securities into common stock?
  • The conversion price directly influences whether an investor will choose to convert their convertible security into common stock. If the market price of the underlying stock rises above the conversion price, it becomes more attractive for investors to convert, as they can acquire shares at a lower cost. Conversely, if the market price remains below the conversion price, investors may hold onto their securities instead of converting, resulting in potential lost opportunities for equity participation.
• Discuss the relationship between conversion price and dilution for existing shareholders when convertible securities are converted into equity.
  • When convertible securities are converted into equity at the conversion price, it results in the issuance of new shares. This can lead to dilution for existing shareholders, as their ownership percentage decreases with the introduction of additional shares. The extent of dilution depends on how many securities are converted and how significant their impact is relative to the total outstanding shares. Therefore, companies need to manage the conversion price carefully to balance investor appeal while minimizing dilution effects on current shareholders.
• Evaluate how changes in market conditions might affect the strategy behind setting a company's conversion price for its convertible securities.
  • Companies must consider various market conditions when establishing a conversion price for their convertible securities. If market conditions are favorable and share prices are expected to rise, a higher conversion price may be set to attract investors seeking equity upside. However, if market conditions are uncertain or expected to decline, setting a more competitive conversion price may encourage conversions and secure necessary capital. By strategically adjusting the conversion price based on anticipated market trends, companies can optimize financing opportunities while aligning investor interests.

Related terms

Convertible Security: A financial instrument that can be converted into a predetermined number of common shares, often providing investors with both fixed income and equity-like features.

Market Price: The current price at which a security is trading on the market, which can influence the attractiveness of converting a convertible security into common stock.

Dilution: The reduction in existing shareholders' ownership percentages that occurs when new shares are issued, such as through the conversion of convertible securities.