Conversion Ratio

A conversion ratio tells you how many shares of common stock you get if you convert one convertible bond or one share of convertible preferred stock into common stock. A convertible bond or convertible preferred stock is a hybrid security: it pays you interest (if a bond) or a fixed dividend (if preferred stock), but it also carries the right to be exchanged, at your option, for a set number of shares of the issuing company's common stock. The conversion ratio is that set number.

For example, if a convertible bond has a conversion ratio of 25, each $1,000 bond can be turned into 25 shares of common stock. That ratio also implies a "conversion price" — the effective price per share you'd be paying by converting. In this case it would be $1,000 divided by 25, or $40 per share. If the stock is trading above $40, conversion starts to look attractive; if it's trading well below $40, the bond behaves more like an ordinary bond and the conversion feature is mostly irrelevant for now.

The nuance that trips people up is that the conversion ratio is fixed at issuance (subject to standard adjustments for stock splits, stock dividends, or other corporate actions), while the stock price moves constantly. So the value of the conversion right — sometimes called "conversion value" — changes every day even though the ratio itself doesn't. Conversion value is simply the conversion ratio multiplied by the current stock price. People sometimes confuse conversion ratio (a fixed number of shares) with conversion value (a dollar amount that floats with the market).

Also worth noting: converting is usually irreversible and one-directional — you give up the bond or preferred shares and receive common stock, not the other way around, and you typically lose the interest or dividend stream once you convert.