A conversion premium is understood to be the percentage or dollar amount that the current price of a convertible security is more than the amount that would be realized by converting the security into common stock. Investors often check in on the current status of any convertible investments in the portfolio and determine if such a conversion would be in their best interests at a given point in time. Depending on the circumstances, the conversion premium may be quite healthy, making it wise for the investor to execute the conversion.
At the same time, calculating the conversion premium may indicate that the time is not right to make such a conversion. Essentially, when the current market value of the common stock in question is at a price that is lower than the percentage amount currently associated with the convertible security, the investor is wise to do nothing. Choosing to engage in the action of converting stock from the convertible securities is considered to be a waste of time and would result in a loss to the investor.
There are several factors that can impact the dollar or percentage amount of the conversion premium. Some of these have to do with the type of convertible security itself and how such factors as current transaction costs or the duration of the proposed conversion option. In other situations, the size of the common dividends involved may impact the conversion premium in either a positive or negative manner.
It should be noted that is it not unusual for most convertible securities to trade at a price or rate that is higher than the conversion value. However, this is not automatically the case. Sudden changes in the market as well as the several closely related factors to the nature of the security proper may indicate that moving forward with the conversion would not be in the best interests of the investor at the present time. Investors would be well advised to always calculate the conversion premium before moving forward with the conversion.
