what is convertible preferred stock 
convertible preferred stocks are preferred shares that include an option for the holder to convert them into a fixed number of common shares after a predetermined date most convertible preferred stock is exchanged at the request of the shareholder but sometimes there is a provision that allows the company or issuer to force the conversion the value of a convertible preferred stock is ultimately based on the performance of the company s common stock understanding convertible preferred stockcorporations use convertible preferred stock to raise capital these securities are especially useful as a financing medium for early stage companies as they can offer greater flexibility to investors making them an attractive option that is the investor has the promise of regular dividends and the potential for stock price growth in the future preferred stock is a class of equity capital issued by a corporation that has a higher claim on assets and earnings than common stock preferred shares typically pay steady dividends while common stock pays dividends only if and when they are approved by the board of directors based on the company s recent financial performance preferred shares do not usually come with voting rights as common shares do as such preferred stock is often thought of as a hybrid between a corporate bond and common stock convertible preferred stock is distinguished by the fact that it contains an embedded option that allows the holder to trade it for a specified number of common shares at some point in the future this conversion option provides a potential upside for the holder as the value of the common stock could increase over time meanwhile it has the benefits of preferred stock however this advantage comes at a price convertible preferred stock typically trades at a premium over regular preferred shares and may also carry a comparatively lower dividend rate convertible preferred stock termscommonly used terms when referring to convertible preferred stock are as follows example of convertible preferred stockconsider a convertible preferred stock issued by the hypothetical company abc inc at 1 000 with a conversion ratio of 10 and a fixed dividend of 5 the conversion price is thus 100 and abc s common shares need to trade above this threshold for the conversion to be worthwhile for the investor even if the common shares are trading close to 100 it may not be worth it to convert since the preferred shareholder will be giving up a fixed 5 dividend and a higher claim on company assets in the event of liquidation if the convertible preferred stock is trading at 1 000 and the abc common shares are trading at 80 then the conversion premium would be 200 i e 1 000 80 10 or 20 200 1 000 if the common shares move up to 90 the conversion premium shrinks to 100 or 10 thus the conversion premium influences the price at which the convertible preferred stock trades in the market a high conversion premium implies that the underlying common shares are trading well below the conversion price and there is little possibility of a profitable conversion in this case the convertible preferred stock will act more like a bond and will be susceptible to changes in interest rates if the conversion premium is very low implying that the common stock is trading quite close to the conversion price the convertible preferred stock will be sensitive to changes in the underlying common shares those of abc in this case and will act like straight equity as the common shares increase in price a conversion becomes more attractive if the abc common shares move to 110 the preferred shareholder gets 1 100 110 10 for each 1 000 preferred stock that s a gain of 10 if the investor converts and sells the common shares at 110 the danger in converting is that the investor then becomes a common shareholder and is at the mercy of swings in the stock price if the price of abc stock falls to 75 after conversion and the investor continues to hold the common shares they would now own 750 75 10 in common shares for each preferred stock worth 1 000 that they previously owned this represents a notional loss of 250 and the investor no longer receives the 5 preferred stock dividend or has a preferential claim on assets 