SIE: Convertible Preferred Stock

Convertible Preferred Stock

Like participating preferred, convertible preferred stock allows shareholders to participate in the growth of a company. These investors have the right to convert their preferred shares to common stock at a set conversion ratio. This exchange may occur any time at the investor’s sole discretion. If a $100 certificate may be traded for 5 shares of common stock (at $20 per share) and the value of the common stock rises to $40, the price for the preferred stock in the secondary market will rise to around $200 ($40 x 5 shares). The market value of the preferred shares if converted is called the parity price. When the preferred stock is trading at this price, we say that it is trading at parity. The preferred shareholder has the option to sell the certificate or convert the issue and receive five shares of stock. Because convertible preferred stock can be converted to common stock, its price is more dependent on the price of the company’s common stock than on changes in interest rates.

The following two equations will be helpful for the exam:

face value / convert