What is Conversion Ratio
The conversion ratio is a measure used in the field of finance to determine the number of securities that can be converted into another security. It is commonly used in the context of convertible bonds, which are bonds that can be converted into shares of stock at the holder's discretion. The conversion ratio is typically stated in the bond indenture and determines the number of shares of stock that can be received for each bond.
For example, if a convertible bond has a conversion ratio of 10, it means that for every bond held, the holder can convert it into 10 shares of stock. The conversion ratio can be adjusted based on various factors, such as changes in the market price of the underlying stock or changes in the terms of the bond.
The conversion ratio is an important factor to consider when evaluating convertible bonds, as it can affect the value of the bond and the potential return on investment for the bondholder. A lower conversion ratio may result in a lower potential return, while a higher conversion ratio may offer a higher potential return.
- Convertible Bond - The most common financial instrument where the conversion ratio is applied. The conversion ratio tells you how many shares of common stock a bondholder can get from converting one convertible bond.
- Conversion Price - This is directly related to the conversion ratio, often used to determine the conversion ratio itself. For example, Conversion Ratio = Par Value of Convertible Bond / Conversion Price.
- Preferred Stock - Another type of convertible security where a conversion ratio might be specified, determining how many shares of common stock each preferred share can be converted into.
- Strike Price - In options trading, the strike price serves a similar role to the conversion price in convertible bonds, which subsequently influences the conversion ratio.
- Capital Structure - The composition of debt and equity in a firm, which can be affected by the conversion of securities based on the conversion ratio.