A convertible security is a financial instrument whose holder has the right to convert it into another security of the same issuer. Most convertible securities are convertible bonds or preferred stocks that pay regular interest and can be converted into shares of the issuer's common stock. Convertible securities typically include other embedded options, such as call or put options. Consequently, determining the value of convertible securities can be a complex exercise. The complex valuation issue may attract specialized professional investors, including arbitrageurs and hedge funds who try to exploit disparities in the relationship between the price of the convertible security and the underlying common stock. Types Types of convertible securities include: Convertible bond Reverse convertible bond Convertible preferred stock Asset-linked bond: Although a bond with an asset warrant is a type of convertible security, regular warrants are not. A regular warrant provides an equity option, where the holder may opt to buy newly issued shares at a determined exercise price and date. Equity capital notes are similar to warrants, except that there is no exercise price. Asset-linked note Bond with asset warrant Characteristics of convertible bonds and preferred stock Because convertibles are a hybrid security, their market price can be affected by both movements in interest rates (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. 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. The conversion ratio - the number of shares the investor receives when exchanging the bond for common stock - is specified in the bond's indenture. {| class="wikitable" |- | market conversion price = market price of convertible bond / conversion ratio Once the actual market price of the underlying stock exceeds the market conversion price embedded in the convertible, any further