Conversion Premium
Conversion Premium is the amount in which the price of convertible security (bonds) exceeds the price of another security (common stock) that may be converted in the future. Some marketable security may be able to convert to another form at a specific date in the future. The most common form is the convertible bond which can convert to the common stock at any given time. One convertible bond will be exchanged for X amount of commons stock in the future.
Conversion premium only happens to the convertible security include convertible bond, Reverse convertible bond, bond with asset warrant, and so on. These securities will be able to convert from debt to equity on the maturity date. When the price of debt is higher than the price of converted equity, it will generate the conversion premium.
Conversion Premium Formula
Conversion premium is the comparison between current price of debt (bonds) and conversion price.
Conversion Premium = Market Price – Conversion Price
Market price: is the market value of the debt security
Conversion Price: is the market value of converted security (equity)
Conversion price = Conversion ratio x current market price
Conversion Premium Example
Company issue 8% convertible bond with par value of $ 1,000. The bond will be converted to common stock on the maturity date at rate of 1:5. It means one bond will be able to exchange to five common stocks on the maturity date.
At the end of 2nd year, the bonds market price is $ 1,100 while the market price of commons stock is $ 210 per share.
Please calculate the conversion premium of the convertible bond.
Conversion Premium = Bonds Market Price – Conversion price
=$ 1,100 – ($ 5 share x $ 210 per share) = $ 50 per share
The conversion price is $ 1,050 which is the amount that investors going to receive if they convert the bonds into the equity security.
The investors have to pay the bonds market price ($ 1,100) in order to receive the equity security with a value of $ 1,050.
Convertible Securities
Convertible securities are a type of investment that can be converted into another form of security, such as shares of stock. For example, a bond may be convertible into shares of common stock. Convertible securities offer investors flexibility and the ability to participate in the upside potential of the underlying security.
Convertible securities are often used by companies to raise capital and are especially popular with startup companies. Convertible securities typically have a higher interest rate than non-convertible securities, making them more attractive to investors. However, the potential for loss is also greater, as there is no guarantee that the underlying security will increase in value.
A convertible bond is a type of corporate bond that gives the bondholder the option to convert their debt into equity shares of the company. This can be an attractive option for investors looking for potential upside in the stock price, while still getting the stability and income of a bond. Convertible bonds typically have a higher interest rate than regular bonds, to compensate for the additional risk. However, if the stock price falls, the bondholder may not be able to convert their bonds into shares, and could end up losing money. Convertible bonds can be a complex investment, so it’s important to understand all the risks and potential rewards before investing.
Conversion price
The term “conversion price” refers to the price at which convertible securities can be converted into, it is usually the common stock. For example, a bond can be converted into 100 shares of common stock if the stock price is above $50 per share. The conversion price is $ 5,000 (100 shares * 50 shares) .
The conversion price is typically set at a premium to the current market price of the underlying stock, providing an incentive for investors to convert their securities.
Convertible securities are often used by companies as a way to raise capital without having to issue new equity. The conversion price is an important factor in determining the value of convertible securities, and it is important for investors to understand how it works before investing.
Conversion premium
A conversion premium is the difference between the price of a convertible security and the underlying security. The conversion premium is often used to calculate the value of a convertible bond. A convertible bond is a bond that can be converted into shares of stock at a predetermined price. The conversion price is usually set at a premium to the current market price of the underlying stock.
The size of the conversion premium can have a significant impact on the value of a convertible bond. However, a high conversion premium also means that the bonds are more expensive and may be less attractive to potential investors. As a result, issuers must carefully consider the size of the conversion premium when issuing convertible bonds.
Disadvantage of Convertible Security
Company forced to convert the bonds
A company has the right to forcibly convert bond to equity if it is in the best interest of the business. This can be done to reduce the amount of debt that the company owes, or to raise capital for the business. Forcing bondholders to convert their bonds into equity can be a risky move, as it can lead to a loss of confidence in the company and its ability to repay its debts. However, if the company is in dire financial straits, it may be necessary to take this step in order to keep the business afloat.
Complexity
Convertible bonds are complex securities that can be converted into another security, typically shares of common stock, at a predetermined price and time. Convertible bonds offer investors both the safety of a fixed-income investment and the potential for capital appreciation if the underlying security’s price increases. While convertible bonds may seem like a perfect investment, they also come with a number of risks. For example, if the price of the underlying security falls, the bondholder may be forced to convert the bond into shares at a loss. In addition, convertible bonds typically have high-interest rates, which means that they carry more risk than non-convertible bonds. As a result, investors should carefully consider the risks and rewards before investing in convertible bonds.
