Understanding Conversion Premium: A Guide for Investors

A conversion premium is an amount of money that is paid that exceeds the value of a security. The owner of the bond has the opportunity to convert back on into a specified number of shares of common stock. In order to calculate the convertible premium, you first have to know the value of the shares of stock that the bond can be converted into.

An Example

For example, if the bond can be converted into 10 shares of common stock that are worth $90 apiece, the value of that conversion would be $900. If the bond is trading for $1100, the conversion premium would be the difference between the $1100 and $900 or $200.

Trading for a Premium

Convertible bonds often trade for a higher price than what the conversion into a different security would equal. They are willing to pay a premium for this type of security because it has multiple options. They can hang onto the bond and receive regular coupon payments or they have the right to convert it into stock.