Conversion & Parity Pricing — Q&A
Questions
Q1. What does convertible preferred stock allow, and why must voter approval be obtained to issue it?
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Exchange for common stock of the same issuer. Issuing convertible securities is dilutive (increases common shares outstanding, reduces each holder’s %) — requires stockholder (voter) approval.
Q2. State the conversion ratio and conversion price formulas.
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CR = Par ÷ Conversion price; CP = Par ÷ Conversion ratio. Example: $100 par, CP $25 → CR = 4:1.
Q3. An investor buys 100 shares of $100 par, 5% convertible preferred at $100 (4:1 ratio). Common rises from $15 to $30; they convert and sell. Gain or loss?
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Cost $10,000 → 400 common shares × $30 = $12,000 sale → $2,000 gain. Convertibility adds capital appreciation potential beyond fixed dividends.
Q4. Callable at 102, preferred market $103, common $26, conversion price $25, call in 60 days. Best action: (A) allow call, (B) sell preferred, (C) convert and sell common, (D) hold?
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(C) Convert and sell — value per share: call $102, sell preferred $103, convert 4 × $26 = $104 (best). (D) unrealistic — shares will be called.
Q5. $50 par preferred at $55 market, conversion price $10. What is the common stock parity price?
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CR = $50/$10 = 5:1. PP (common) = $55/5 = $11 per common share — equivalent cost if you buy preferred and convert.
Q6. $30 par preferred, conversion price $15, common at $12. Preferred stock parity price?
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CR = 2:1. PP (preferred) = $12 × 2 = $24 — value based only on conversion feature. Arbitrage if preferred trades below $24.
Q7. If buying convertible preferred, converting, and selling common produces instant profit, what is that called?
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An arbitrage opportunity. Traders may buy preferred and short common simultaneously to lock in the spread until conversion delivers shares to cover the short.
Q8. After a 4:1 common stock split, an anti-dilution covenant adjusts terms on $100 par preferred (original CP $50, CR 2:1). New conversion ratio and price?
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New CR = 2 × 4 = 8:1; new CP = $50/4 = $12.50 (or $100/8). 🔑 Stock split under anti-dilution: ratio UP, conversion price DOWN — conversion value preserved.
Q9. Why is convertible preferred issued with lower dividend rates than non-convertible?
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Convertibility is a beneficial feature for investors → higher market prices, lower yields, and lower stated dividend rates at issuance.
Sources
| # | Source | Publisher |
|---|---|---|
| 1 | Achievable Series 65 — chapter 1.1.7 | Achievable (course text) |