Some businesses find equity offerings to be more appealing than debt because there is no requirement to repay the money raised through an offering of shares. However, a company may decide to restructure its existing convertible debt by exchanging it for equity, thereby reducing some debt, if it is unable to meet the minimum listing dollar amount set by an exchange.
Equity vs. debt
Equity and debt are two important tools for capital fundraising. Typically, when securities are convertible, stockholders have the option to convert them. However, there are some differences between the two, such as:
What is the conversion ratio?
The number of shares of common stock an investor will receive when converting each of their convertible securities, such as convertible preferred stocks or convertible bonds, is known as the conversion ratio. The conversion ratio for these convertible securities is determined by the company at the time of issuance. However, they may affect the relative price of a security. For instance, if the conversion ratio is higher, the stockholder will receive more common shares for each convertible share they exchange.
The conversion premium is determined by the conversion ratio, which has an impact on the trading prices of convertible securities. A lower conversion premium increases the likelihood that the price of the security will follow changes in the price of the security it converts to. For instance, if the conversion premium is lower, the convertible bond’s price is more likely to fall if the price of the common stock share it converts into falls first.
Elements of the conversion ratio formula
You divide the par value of the convertible security by the equity conversion price to determine the conversion ratio. Heres what each of these elements means:
Par value
Par value reflects the face value of a security. For instance, a bond with a $500 face value has a $500 par value. Par value is crucial for showing how much a bond or security will be worth when it matures. When dealing with stocks, it might be an arbitrary figure though to avoid problems if the stock’s value falls below its par value.
Convertible security
A convertible bond or convertible preferred stock are examples of convertible securities. A convertible stock is a hybrid equity product as opposed to a convertible bond, which is a hybrid debt product. A convertible security may be exchanged by stockholders for another kind of security issued by the same company. Convertible securities typically convert into shares of the issuer’s common stock when discussing conversion ratios.
Conversion price of equity
The price per share at which a convertible security can be converted into common stock is referred to as the conversion price of equity. Before releasing convertibles to the public, management of an organization may choose the conversion price of equity. Typically, the conversion price of equity is much higher than the current price of common stock in order to make sure that the common shares are desirable and may appreciate in value.
How to calculate conversion ratio
Here are the steps to follow for calculating conversion ratio:
1. Identify the par value
Begin by determining the par value of the convertible item. This represents the face value of the stock or bond. Most items list this in the agreement.
2. Determine the conversion price
Identify the conversion price. This is the price for each common share. This information ought to be included in the bond indenture for convertible bonds conversions. This information should be contained in the security prospectus for conversions involving convertible preferred shares.
3. Calculate the conversion ratio
You can determine the conversion ratio once you know the par value of your convertible item and the conversion price. Divide the convertible’s par value by the conversion price to get the conversion ratio. The number of shares the holder will receive is the outcome.
Example of calculating conversion ratios
Examples of conversion ratios for various categories of convertible securities are provided below:
Example with convertible bonds
A shareholder owns a convertible bond with a $2,000 par value. The conversion price for each stock share is $10. Divide $2000 by $10 to get 200 shares of the issuer’s common stock, the stockholder calculates.
Example with convertible preferred shares
On June 1st, a shareholder buys 100 shares of Litmus Financial convertible preferred stock. Each share pays a 5% dividend, and the shares are convertible on January 1 of the next year Three shares of Litmus Financial are equal to one share of preferred stock.
However, once the conversion date arrives, the prices changed. Converting shares would result in a loss of $20 per share because preferred shares currently trade at $50 and common shares at $10. However, they calculate the stock price to trade at in order to break even with the conversion by dividing the current price of preferred shares by the conversion ratio. In this case, $50 divided by a threefold conversion rate equals $16. 67, meaning common stocks need to trade at least $16. 67 for the conversion to break even.
Chapter 20- Convertible bonds: How to determine the conversion price, ratio and value?
FAQ
What is the formula of conversion ratio?
Simply dividing the total number of ad interactions that can be linked to a conversion during the same time period by the number of conversions results in conversion rates. For example, if you had 50 conversions from 1,000 interactions, your conversion rate would be 5%, since 50 %C3%B7 1,000 = 5%
What is a 1 1 conversion ratio?
The “conversion ratio” is the first factor to consider because it determines how many shares of common stock each share of preferred stock converts into. This number starts at one-to-one, or 1:1. Thus, each share of preferred stock initially converts into one share of common stock.
