What Is a Conversion Ratio? (With How-to Guide and FAQs)
By Indeed Editorial Team
Published May 14, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Investors refer to conversion ratios when reviewing individual securities and shares. This requires an analysis of the value of shares. Acquiring an understanding of conversion rates can help you determine whether to invest in particular securities. In this article, we discuss conversion rates, explore the differences between conversion rates and conversion price, review the differences between equity and debt, and answer several frequently asked questions.
What is a conversion ratio?
The conversion ratio refers to the number of shares obtained at the time of conversion for individual securities. A higher ratio results in a higher number of common shares exchanged for each convertible security. You obtain the ratio after issuing the convertible security and determining the conversion's impact on the price of the security. You can calculate the ratio by dividing the security's par value by the conversion price of equity. It's also beneficial to consider the convertible debt and how it allows the holder to transfer debt into equity.
The primary forms of capital fundraising are equity and debt. When you have a debt, it typically has a due date for repayments. It's often less expensive to raise capital by issuing debts than by obtaining equity. This is due to tax considerations. You typically don't repay equity, which is helpful when you experience lower earnings. If you want to increase capital with equity, this releases ownership, which considers voting rights. Shareholders benefit from the increase of share prices when companies increase capital and profits. Here are more considerations regarding the ratio:
The interest rate you pay to debt holders remains the same.
Equity and debts have advantages and disadvantages.
These ratios can be bond indentures or prospectus.
The conversion rate tells investors how many shares they can obtain for a convertible bond or stock.
What is the difference between conversion rate and price?
The conversion price differs from the ratio in that it provides you with the price at which every share of a convertible security, such as a corporate bond, converts to a stock that you can purchase on the stock market. Companies decide this price when they establish the ratio for a convertible security. Companies use conversion prices when they want to increase their capital through debt or equity.
What is the difference between equity and debt?
Equity and debt contribute to capital fundraising. Here are the primary differences between them:
Earnings: Equity is beneficial when you experience lower earnings because it doesn't require repayment.
Effects on credit: Existing debts can impact your credit.
Payment requirements: You typically require repayment of debts, but not of equity.
Shareholder benefits: You can benefit from having more equity, depending on the share price appreciation and your overall earnings.
Elements of the conversion rate formula
If you want to calculate the ratio of conversions, you typically do this by dividing the par value by the conversion price. Here's more information about the various elements involved in calculating the ratio of conversion:
The par value, otherwise called the nominal value, refers to the surface value of a security. For example, if you have a bond with a surface value of $1,000, the par value is $1,000. The par value is important when you want to demonstrate the value of a bond or security after it achieves maturity. This can also be an arbitrary value if you manage stocks to prevent obstacles when a stock value falls below the par value.
Professionals typically identify the par value in the corporation's charter. This is typically lower than the legitimate value. Stock certificates usually include the price of shares in addition to their par value.
Convertible securities can include convertible bonds and preferred stocks. Convertible bonds are also hybrid debt products and differ from convertible stocks, which refer to hybrid equity products. Stockholders can convert convertible securities into other forms of security with the same issuer. When managing conversion rates, professionals can transfer convertible securities to shares of the issuer's stock.
Conversion price of equity
The conversion price of equity considers the price of shares and the rate at which professionals convert convertible securities to stocks. Members of upper management within organizations can determine the conversion price of equity before they issue their convertibles to the public. The conversion price of equity is usually larger than the price of the stock, and it helps to ensure that the common shares are appealing and that they can increase in value.
How to calculate the conversion rate
Follow these steps to calculate the conversion rate:
1. Assess the par value
The first step in calculating the ratio is to determine the par value. This refers to the overall value of the stock or bond. When professionals review share agreements or stock certificates, they typically list the par value. This value helps to reassure investors that they didn't buy a share below the price of the par value.
2. Consider the conversion price
Investors benefit from identifying the conversion price. This refers to the price of every share bought by investors. When investors review convertible bonds, indentures highlight this information. Investors who work with conversions with convertible preferred shares can review this information in the security prospectus.
3. Calculate the conversion rate
After calculating the par value and conversion price of convertible items, you can calculate the conversion price ratio. You typically do this by dividing the par value of the convertible by the conversion price of shares. This provides the shareholder with the number of shares they receive.
Frequently asked questions
Here's a list of frequently asked questions about conversion rate:
What is a good conversion rate?
A good ratio depends on the industry of the shareholder, along with the niche ad goals. If shareholders determine that they have a lower ratio than they anticipated, it's beneficial to review the industry and assess whether the ratios are low. This provides investors with more information about whether it's beneficial to sell their shares.
Can the market price be lower than the conversion value?
Investors consider a conversion rate as busted when it has a trading price or value below that of the conversion value. They also determine whether the convertible security has reached its lowest worth by reviewing how far below the value of the convertible security fell. This helps investors to determine whether they want to invest in a stock.
What is the straight value of bonds?
The straight value of bonds refers to the value of the security, and it doesn't consider the possibility of the security converting to a common stock. The straight value subsequently refers to the value of the convertible bond without the conversion option. Straight value is also known as investment value or bond value.
Examples of conversion rate calculations
Here are some examples of conversion rate calculations:
Convertible bonds example
Here's an example of a calculation for convertible bonds:
A shareholder obtains a convertible bond. This convertible bond has a par value of approximately $2,000. The shareholder discovers that the conversion price for their stock shares is $10. The shareholder then divides $2,000 by $10 to learn the number of stocks they receive. This provides them with 200 shares.
Convertible preferred shares example
Here's an example of a calculation for convertible preferred shares:
A shareholder decides to purchase 100 shares of a company called Montreal Limited. They make this purchase of convertible preferred stock on January 29. The shares provide the shareholder with a dividend of 5%, and they're convertible on the first day of the financial period of the following year. The shares of the preferred stocks equal approximately three shares of Montreal Limited. On January 1 of the following year, the shareholder reviews their shares for the conversion date. They discover that there are price changes.
Now, the preferred shares are $50, and the common shares are $10. This results in a $20 loss per share if the shareholder decides to convert them. If the shareholder divides the current price of the share by the conversion rate, they can determine the rate required to sell the stock at the same price as the conversion. To do this, they divide the $50 preferred share rate by three, which equals $16.67 per share. This means that if the shareholder wants to reduce risk or losses, they require a common stock price of $16.67.
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