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Definition: Conversion Price
It is the price at which a convertible security like convertible bonds, preference shares can be converted into common stock. The number of shares to be received is determined by the conversion ratio. For e.g. if the conversion ratio is 10, then the investor can receive 10 shares per convertible debenture.
The conversion price is determined by dividing the market price of the convertible security by the conversion ratio. For e.g. If a holder wants to convert the convertible bonds of a company into shares, if the current market price of the bond is $500, and if the conversion ratio is 10 shares per bond, then the conversion price is given by $500/10 = $50 per share.
The conversion price is determined when the convertible securities are issued and can be found in the security prospectus such securities. The conversion price is usually set at a higher price than the current value of the common stock so as to make the conversion desirable only if the value of the company’s share appreciate over a period of time.
Example: In 2002, Gen Corp had sold $125 million worth 5 year subordinated notes that could be converted into the company’s shares. The coupon rate was 5.75% and the face value of each note was $1000. The notes had a conversion price of $18.42, hence the conversion ratio was (1000/18.42) = 54.288 shares per note. The conversion price of $18.42 was at 27% premium when compared to $14.50, which was the closing price of the common stock on the previous day. A lower conversion price would have allowed Gen Corp to sell the notes at a lower coupon rate and it would have also resulted in additional shares being issued when the notes would have been submitted for conversion.