Definition§
Conversion Parity refers to a situation where the market price of a convertible security is equal to the current value of the underlying common stock after taking into account the conversion ratio. This concept is relevant for financial instruments like convertible bonds or convertible preferred shares, which can be exchanged for a specified number of common shares.
Examples§
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Convertible Bond Example:
- A convertible bond with a par value of $1,000 and a conversion ratio of 20:1 implies each bond can be exchanged for 20 shares of stock.
- If the current stock price is $50 per share, the conversion value of the bond would be 20 * $50 = $1,000.
- In this case, the convertible bond is at conversion parity because its market value equals the conversion value.
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Convertible Preferred Stock Example:
- A convertible preferred stock might have a conversion ratio allowing it to be converted into 10 shares of common stock.
- If the common stock is trading at $30 per share, the conversion value is 10 * $30 = $300.
- If the market price of the convertible preferred stock is also $300, then it is at conversion parity.
Frequently Asked Questions (FAQs)§
What happens when a convertible security is not at conversion parity?§
When a convertible security is not at conversion parity, it can either be trading at a premium or at a discount. If it’s above the conversion value, it is considered to be trading at a premium due to factors like higher coupons or interest. If it is below, it might be unattractive for conversion.
Why is conversion parity important for investors?§
Conversion parity gives investors a benchmark to assess whether it’s advantageous to convert a security into stock or hold onto it. Investors use parity to gauge relative value and make informed decisions regarding their investments.
How do market conditions affect conversion parity?§
Market conditions, such as stock price volatility, interest rates, and overall market sentiment, can influence the value of both the convertible security and the underlying stock, thereby affecting conversion parity.
Related Terms with Definitions§
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Convertible Bond: A bond that can be converted into a predetermined number of common stock shares.
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Conversion Ratio: The number of shares of stock that one unit of a convertible security can be converted into.
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Conversion Price: The price at which a convertible bond or stock can be converted into common shares.
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Convertible Preferred Stock: Preferred stock that can be converted into a specified number of common shares.
Online References§
- Investopedia: Conversion Parity
- The Balance: Understanding Convertible Securities
- Financial Times Lexicon: Conversion Price
Suggested Books for Further Studies§
- “Convertible Securities: A Complete Guide to Investment and Corporate Financing Strategies” by Kevin McCarthy.
- “Convertible Bonds: The Low Risk, High Yield Alternative to Buying Stocks” by Sean Brodrick.
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat.
- “Investments” by Charles P. Jones, which provides a comprehensive overview of different types of securities including convertibles.
Fundamentals of Conversion Parity: Finance Basics Quiz§
Thank you for exploring the key components of conversion parity and testing your knowledge with our finance basics quiz. Keep enhancing your understanding of financial concepts!
