Editing Convertible security (section)

==Characteristics of convertible bonds and preferred stock==
Because convertibles are a hybrid security, their market price can be affected by both movements in [[interest rate]]s (like a conventional bond) and the company's [[stock price]] (because of the embedded option to convert to the underlying stock). The minimum price at which a convertible bond will trade is based on its fixed income characteristics: the stream of coupon payments and eventual maturity at par value. This is known as its "bond equivalent" or "straight bond" value. The price of the convertible bond will not drop below straight value if the stock price declines. In return for this degree of protection, investors who purchase a convertible bond rather than the underlying stock typically pay a premium over the stock's current market price.<ref>{{cite book |title=Fabozzi op cit |page=376}}</ref><ref>{{cite book |title=Ritchie op cit |page=288}}</ref>

The price that the convertible investor effectively pays for the right to convert to common stock is called the ''market conversion price'', and is calculated as shown below.<ref>{{cite book |last1=Fabozzi |first1=Frank J. |title=Bond Markets, Analysis and Strategies |date=1996 |publisher=Prentice-Hall, Inc. |location=Upper Saddle River, NJ |isbn=0-13-339151-5 |page=376 |edition=third}}</ref> The ''conversion ratio'' - the number of shares the investor receives when exchanging the bond for common stock - is specified in the bond's indenture.<ref>{{cite book |title=Ritchie op cit |page=287}}</ref>

:<math>\mathsf{market\ conversion\ price} = \mathsf{market\ price\ of\ convertible\ bond} / \mathsf{conversion\ ratio}</math>

Once the actual market price of the underlying stock exceeds the market conversion price embedded in the convertible, any further rise in the stock price will drive up the convertible security's price by at least the same percentage. Thus, the market conversion price can be thought of as a "break-even point."<ref>{{cite book |title=Fabozzi op cit |page=376}}</ref>

If the price of the stock decreases to the point that the straight bond value is much greater than the conversion value, the convertible will trade much like a straight bond. This is referred to as a ''bond equivalent'' or  ''busted convertible.''<ref>{{cite book |title=Fabozzi op cit |page=378}}</ref>