SIE: Convertible Preferred Stock

Convertible Preferred Stock

Like participating preferred, convertible preferred stock offers shareholders the chance to participate in the growth of a company. Convertible preferred stock offers investors the right to convert their preferred shares to common stock at a set conversion ratio. In return, the issuing company can issue convertible preferred shares with a lower dividend than a preferred share without a conversion option, thereby saving the company money on dividend payments. Typically, conversion of convertible preferred to common may occur after some preliminary period, at the investor’s discretion, but it only makes economic sense if the price of the common stock rises to the point that, when multiplied by the conversion ratio, the value of common shares equals the par value or market price of the convertible preferred stock. If a $100 par value convertible preferred share may be exchanged for five shares of common stock and the value of the common stock rises from $20 to $40, the price for the convertible 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 sel