Conversion ratio
The conversion ratio is the number of common shares an investor receives when converting a convertible bond or convertible preferred stock. It equals the security's par value divided by its conversion price.
The conversion ratio tells the holder of a convertible security — a convertible bond or convertible preferred stock — how many shares of common stock they receive upon conversion. The formula is conversion ratio = par value ÷ conversion price. The ratio is fixed when the security is issued and adjusts only for events like stock splits.
For example, a convertible bond with a $1,000 par value and a $40 conversion price has a conversion ratio of $1,000 ÷ $40 = 25 shares. Convertible preferred stock works the same way: a $100 par preferred with a $25 conversion price converts into 4 common shares.
The ratio also drives parity price calculations, which compare the values of the convertible and the underlying stock. Parity price of the stock = market price of the convertible ÷ conversion ratio; parity price of the convertible = stock price × conversion ratio. If the bond above trades at $1,100, the stock's parity price is $1,100 ÷ 25 = $44. When the stock trades above parity, converting (or arbitrage) becomes attractive; below parity, the security is worth more left unconverted.
Convertible securities appear throughout the Series 7, Series 65, and Series 66 exams. Practice computing the conversion ratio from par and conversion price, finding parity prices in both directions, and deciding whether conversion benefits the investor at a given market price.
Key takeaways
- Conversion ratio = par value ÷ conversion price.
- A $1,000 par bond with a $40 conversion price converts into 25 common shares.
- Parity price of the stock = convertible's market price ÷ conversion ratio.
- The ratio is set at issuance and adjusts for stock splits and stock dividends.
- The Series 7, Series 65, and Series 66 exams test conversion ratio and parity price math on convertible bonds and preferred stock.