conversion premium

The percentage by which the conversion price of a convertible security exceeds the current market price of the underlying common stock.

The conversion premium measures the extra cost an investor pays for a convertible security (such as a convertible bond or convertible preferred share) relative to buying the underlying common stock directly at current market prices. It is expressed as a percentage of the stock's current market value. This metric helps investors evaluate the trade-off between the fixed-income protection of the bond and the upside potential of the equity. To calculate the conversion premium, analysts first determine the conversion price, which is the par value of the bond divided by the conversion ratio (the number of shares received upon conversion). The difference between this conversion price and the current stock price is then divided by the current stock price to yield the premium percentage. Investors care about this metric because it dictates how the convertible security will behave. A high conversion premium means the stock price is far below the conversion price, making conversion unlikely in the near term; the security will trade like a traditional corporate bond, sensitive to interest rates and credit spreads. A low conversion premium means the stock is close to or above the conversion price, meaning the security will trade in tandem with the stock, offering high equity sensitivity but less downside protection. A common pitfall for retail investors is buying a convertible bond with an extremely high conversion premium, expecting equity-like gains, only to find the stock never reaches the conversion threshold before maturity. Conversely, when the premium is very low, the bond's price will fall almost as fast as the stock during a market downturn, neutralizing the bond's typical downside floor.

Company A issues a convertible bond with a par value of $1,000 and a conversion ratio of 20, meaning the bond can be converted into 20 shares of common stock. This implies a conversion price of $50 ($1,000 / 20). If Company A's stock is currently trading at $40 per share, the conversion premium is ($50 - $40) / $40 = 0.25, or 25%.