What’s a conversion price?

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Conversion pricing has to do with the pricing structure of various types of convertible securities. The convertible security in question can be preferred shares of stock or bonds issued by a particular company. Under the conversion price approach, these types of securities may be converted into common stock when a specific set of circumstances occurs.

Within the security’s overall purchase structure, the conversion price is fixed at the time of issuance. The exact details of the conversion price will appear in one of two different documents, depending on the type of security in question. With preferred stock, the information will be found in the body of the prospectus. If the security in question is a convertible bond issue, the details will be included in the bond indenture. In most countries, there are no provisions for adding a conversion price clause to stock or bond issues after the fact.

Within the overall initial purchase structure, the conversion price helps set several perimeters that come into play. Often, the conversion price will play a role in deciding how many shares can be received as part of the purchase. This is usually achieved by taking the principal value of the stock and dividing that figure by the considered conversion price.

In general, the conversion price is fixed at a rate per share higher than the current unit price on the open market. Part of the reason for this has to do with the fact that the conversion price is often used when it is anticipated that there may be stock splits in the offering over a short period of time. A conversion pricing scheme may also be put in place when the security is expected to rise significantly in value within a reasonable period of time. In both scenarios, the higher purchase price the investor pays at the time of the acquisition is offset by the higher returns realized at a later date.

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