Syndicate
What the Conversion Premium of Discount Means
A conversion premium is the exceeding amount between the conversion value of a convertible bond and the price it is sold at. A convertible bond is generally sold at a premium price over the straight bond value, and the equity’s conversion value.
For example, Navistar International issued senior convertible bonds at 30% conversion premium at a closing equity price of $26.70 in a private placement in December 2002.
Convertible bonds prices are usually priced as a percentage of its conversion value, which is also known as the conversion premium. For example, a convertible bond that is being sold at $1000 with a straight bond value of $798 and a conversion value of $852 is negotiated at a 17.4% conversion premium.
Conversion premium = Price of bond – Conversion value Conversion value
= $1000 - 852
852
= 17.4%
In 1999, the Amazon.com, Inc., sold $1.25 billions in convertible bonds at 27% conversion premium.
Many years ago, Battle Mountain, a gold mining company, had convertible bonds at 6% being negotiated at 141% premium over its equity value, while another company, Cover D?Alene, had a 7% convertible bond that was being negotiated at 31% premium over its equity value. So, what does conversion premium mean and how can it be interpreted?
The conversion premium is affected by diverse factors, a company with a volatile stock price has a larger conversion premium (owing to the fact that conversion is more likely with a volatile stock). After a convertible is issued conversion premium decreases if stock prices raise. For example, Cover D?Alene?s convertible bond with a smaller premium over its equity value offers a larger appreciation potential than those from Battle Mountain?s higher conversion premium bonds.
Maturity periods also affect the conversion premium. Convertible bonds with long periods of maturity have higher conversion premiums due to the higher possibilities prices have to surpass conversion prices. While shorter the time to maturity lower is the conversion premium.