The convertible's conversion price is the effective price for conversion into stock with the bond at par. At the time of issue, the offering prospectus indicates the common stock price equivalent to the value of the bond at par. This price in turn determines the number of shares of stock into which each bond at par can be converted; this is the conversion ratio.
Confusion often arises among investors because the conversion price is specified in the bond documents, but the conversion ratio is not; it must be calculated. The conversion price is meaningful only when the bond is at par, and it can be calculated by dividing the par value by the conversion price, as shown in Figure 2-2. For example, if the common stock price at which the bond can be converted is $50, then each convertible bond represents 20 shares of stock (par value of $1,000 divided by stated conversion price of $50 = 20).
Investors often focus on the conversion price when they should be paying attention to the conversion ratio. From the moment the bond is brought to market, it trades either above or below par value, depending on the market forces. Since the conversion ratio remains the same whether the bond is at par or not, it is the more important number for investors.
The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
Past performance is no guarantee of future results.