Convertible preference share is a share that gives its investors the option to convert his Preference Shares into Ordinary Equity Shares. However, this option can be availed only after a prescribed period. The shareholder gets his dividend at a fixed rate and investors invest in them as fixed income securities.
How Does it Benefit?
Convertible preferences shares are a good source of fixed income. After a specific period, investors are legible to convert their preference shares into equity shares. This attracts the investors by giving them an opportunity to profit from the rise in the price of the share. Convertible preference shares are suitable for those investors who have the interest in participating in the growth of the company. It works as a tool of hedging against the fall in the price of the preference share.
How Does it Work?
To understand how the conversion will really work, we’ll work it through an example. Let’s say Adam bought 100 convertible preference shares of Xyz company on 24th August, 2009. Now as per the company’s norms, Adam can covert his Preference shares into Equity shares only after the 24th February, 2011. He can convert his one preference share for 4 Ordinary Shares. Therefore, the ‘conversion ratio’ for this would be 1:4. Let’s assume the price of a convertible preference share to be $100 and the price of the equity share to be $20 per share. If Adam opts to convert his Preference Shares to Equity Shares, he will be giving up a share worth $100 for 4 equity shares of $80. Therefore, he’s facing a loss of $20, which is equal to 20%. This loss or difference is called the ‘conversion premium’.
Now divide the price of the preference share with the conversion ratio i.e 100*1/4. This is done to determine the minimum amount you can trade at, to break even the cost incurred. In this case, you can consider converting your shares only if the Xyz company is trading equity shares at a minimum of $25, per share. Anything above the $25 per share mark, you should consider converting your shares. It can be safely inferred that, if the conversion premium is high, convertible preference shares become less attractive and vice versa.
Recent Comments