Conversion Value
The decision to convert a bond will depend on its conversion value and the current market value of the bond. The conversion value, which is the bond’s value if it were to be converted at the present moment, is the conversion ratio times the current market price of the stock. Suppose a convertible bond has a conversion ratio of 50 and the issuer’s stock is currently selling at $24. The conversion value of the bond is 50 x $24 = $1,200. If the bond happens to be selling at $1,200, it is said to be at conversion parity. In other words, conversion parity is when the conversion value of a bond is equal to its current market price.
A price of a convertible bond will never vary far from its conversion parity because, if it did, many investors would try to profit from the difference between a bond’s conversion value and its selling price. This investing strategy of profiting from differences in prices across markets is called arbitrage.
To illustrate, suppose a convertible bond has a conversion value of $1,200 but is selling at $1,160. An arbitrageur (a fancy word for an investor who wants to t