Chapter 22 Convertibles, Exchangables, and Warrants

This provides the convertible holder a fixed return (interest or dividend) and the option to exchange a bond or preferred stock for common stock.

Convertible Security – A bond or a preferred stock that is convertible into a specified number of shares of common stock at the option of the holder.

• This provides the convertible holder a fixed return (interest or dividend) and the option to exchange a bond or preferred stock for common stock.
• The option allows the company to sell convertible securities at a lower yield than it would have to pay on a straight bond or preferred stock issue.

Convertible Security

Conversion Ratio – The number of shares of common stock into which a convertible security can be converted. It is equal to the face value of the convertible security divided by the conversion price.

Conversion Price – The price per share at which common stock will be exchanged for a convertible security. It is equal to the face value of the convertible security divided by the conversion ratio.

Conversion Ratio – The number of shares of common stock into which a convertible security can be converted. It is equal to the face value of the convertible security divided by the conversion price.

Convertible Security

Conversion Ratio = $100 par value / $30 conversion price = 3.33 shares

FunFinMan, Inc., has an issue of 8%, $100 par value preferred stock outstanding. The security has a conversion price of $30 per share. What is the conversion ratio?

Conversion Ratio = $100 par value / $30 conversion price = 3.33 shares

Conversion Example

Conversion terms are not necessarily constant over time.

• Conversion terms are not necessarily constant over time.
• Example: The conversion price on 20-year convertible-debt might “step-up” over time from $30 during the first 5 years, $35 the next 5 years, and $40 for the remaining 10 years until maturity.

• The conversion price is usually adjusted for any stock splits or stock dividends to protect the convertible bondholder from antidilution (known as the antidilution clause).