At the time of issuance, the issuer of a convertible security normally establishes a conversion price ________.
A) below the current book value of the firm's stock
B) equal to the current market price of the firm's stock
C) above the current market price of the firm's stock
D) above the current book value of the firm's stock

Question

Quizplus · Accepted Answer

The conversion price is typically set above the current market price of the firm's stock to provide some level of downside protection for the investor. If the conversion price were set below the market price, there would be no incentive for investors to convert their securities since they could simply sell the stock in the open market for a higher price. Similarly, setting the conversion price below the book value of the stock would provide investors with a discount to the firm's underlying assets, which is also not desirable from the issuer's perspective. Setting the conversion price equal to the market price would not provide much benefit to investors since they would be essentially holding a regular equity share with the option to convert.

At the Time of Issuance, the Issuer of a Convertible