Conversion ratios are simple calculations that refer to the ratio of common shares of stock that are received from the conversion of a convertible security. Using the data that is provided at the time of the purchase of the security, it is possible to determine how many shares of common stock would be accrued if the conversion takes place at a given point in time. Investors often use the process of a conversion ratio to monitor the status of a convertible security in light of current market conditions.
The information required to perform a basic conversion ratio is simple. The formula requires the current par value of the convertible security, and the conversion price of equity. Using these two pieces of information, it is possible to determine how many shares of stock would result if the conversion clause that is part of the terms and conditions of the security were invoked. Depending on the current conditions of the market and the projected future performance of the stock, the conversion may be in the best interests of the investor.
Investors are not the only people who make use of a conversion ratio. Brokers also often employ the formula as part of their ongoing support to clients. This helps the broker to offer suggestions to customers about what to do with convertible securities at a given point in time. If the conversion ratio does not appear favorable in the opinion of the broker, then he or she is likely to discourage the investor from exercising the conversion privilege. Should the conversion ratio indicate that the client would realize a significant return by executing an order to convert the security, the broker would of course recommend this course of action to the investor.
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In general, investors tend to look for convertible securities that exhibit a relatively high ratio. A higher ratio indicates that more common shares are likely to result from executing the conversion at some future point in time. However, the presence of a higher conversion ratio does not necessarily mean that it is always in the best interests of the investor to actually convert the security.