Series 7: 2.9.4.2. Conversion Value

2.9.4.2. 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. A convertible bond’s conversion parity or parity price is the price at which the bond needs to be trading for the conversion ratio times the market price of the common stock to be equal to the bond’s market price.

Example: A convertible bond has a conversion ratio of 50 and the issuer’s stock is currently selling at $24. The bond’s conversion value is $1,200 (50 shares x $24/share). If the bond is selling at $1,200, it is said to be at conversion parity.

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 bu