Actions

Convertible Preferred Stock

Convertible preferred stock is a type of preferred stock that gives the holder the option to convert the preferred stock into a specified number of shares of common stock of the issuing company at a predetermined conversion price. Convertible preferred stock provides the benefits of fixed income from the preferred stock, while also offering the potential for capital appreciation if the stock price of the issuing company rises.

Convertible preferred stock is typically issued by companies that are looking to raise capital while minimizing the cost of borrowing. The preferred stock typically has a higher dividend rate than common stock, and the conversion feature provides an incentive for investors to purchase the preferred stock.

The conversion price of convertible preferred stock is typically set at a premium to the current market price of the common stock, to provide an incentive for investors to purchase the preferred stock. The premium also provides a cushion against any decline in the stock price, as the conversion value of the preferred stock will be higher than the market value of the preferred stock.

If the stock price of the issuing company rises above the conversion price, the holder of the convertible preferred stock may choose to convert the preferred stock into common stock, as the value of the common stock will be greater than the value of the preferred stock. If the stock price falls below the conversion price, the holder of the convertible preferred stock may choose to hold onto the preferred stock and continue to receive dividend payments.

To illustrate some key concepts of convertible preferred stock, consider the following example:

Example: A company issues a convertible preferred stock with a par value of $100 and a dividend rate of 5%. The preferred stock has a conversion price of $50 per share, which is a 25% premium to the current market price of the common stock.

If the market price of the common stock is currently $40 per share, the conversion price of $50 per share represents a potential capital gain of 25% if the stock price rises above the conversion price. If the stock price falls below the conversion price, the preferred stockholder can continue to receive dividend payments.

If the market price of the common stock rises to $60 per share, the preferred stockholder may choose to convert the preferred stock into a common stock, as the value of the common stock will be greater than the value of the preferred stock. The preferred stockholder would receive 2 shares of common stock for every share of preferred stock upon conversion.

In conclusion, convertible preferred stock is a type of preferred stock that offers the option to convert the preferred stock into a specified number of shares of common stock at a predetermined conversion price. Convertible preferred stock provides the benefits of fixed income from the preferred stock, while also offering the potential for capital appreciation if the stock price of the issuing company rises. Convertible preferred stock is typically issued by companies that are looking to raise capital while minimizing the cost of borrowing, and are attractive to investors who are looking for a balance of income and potential capital gains.


See Also

  • Preferred Stock - Convertible preferred stock is a type of preferred stock with the added feature of convertibility, making it the most directly related term.
  • Conversion Ratio - This term specifies the number of common shares that each convertible preferred stock can be converted into, and is a core feature of such securities.
  • Conversion Price - The predetermined price at which convertible preferred stock can be converted into common stock, and is used to calculate the conversion ratio.
  • Dividend - Preferred stock often comes with guaranteed dividends. The nature of these dividends may change if the stock is converted, making this relevant for investors.
  • Capital Structure - Describes how a company uses a mix of debt, equity, and hybrid securities to finance its operations. Convertible preferred stock is a hybrid security that can influence a company‚Äôs capital structure.
  • Corporate Finance - The broader field concerned with the effective management of a company's finances, including decisions about issuing convertible preferred stock as a financing option.