Conversion value represents the equity portion of the convertible bond. It is what the convertible bond would be worth if it were converted into common stock at current market prices. In Figure 2-3, the diagonal line indicates the conversion value. For any stock price, the conversion value is found by multiplying the given stock price times the stated number of common shares received per bond. For example, if a bond can be converted into 20 shares of stock and the stock currently sells at $42 per share, the conversion value of the convertible bond is $840. As we have said previously, the number of shares each bond can be converted into is the conversion ratio and is set at the time the bond is issued.
A Convertible's Equity Value
Like bond investment value, conversion value is a minimum value or price at which the security is expected to sell. If the market price fell below the conversion value, specialists and market makers would quickly take advantage of the situation; the arbitrageur would buy the bond and simultaneously sell an equivalent number of shares of the underlying common stock. The difference between these two values would be a risk free profit to the arbitrageur. Because of this, conversion value, like investment value, becomes a minimum value, below which the convertible's market price should not fall.1
1Upon conversion, any accrued interest is lost. The arbitrageur must take that into account in determining the profit opportunity.
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.