forced conversion

Forced conversion

Occurs when a convertible security is called in by the issuer, usually when the underlying stock is selling well above the conversion price. The issuer thus assures the bonds will be retired without requiring any cash payment. Upon conversion into common, the carrying value of the bonds becomes part of a corporation's equity, thus strengthening thebalance sheet and enhancing future debt capability.

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Forced Conversion

In a callable convertible security, a situation in which the issuer calls the security, which requires the holder to exercise the conversion option and exchange the security for common stock. An issuer may authorize a forced conversion when interest rates decline and it can issue the same amount of debt at a lower cost of capital. However, a forced conversion may not be advantageous to the security holder because common stock is riskier and the combination of dividends and capital appreciation may not equal the coupon rate the holder was receiving prior to conversion.

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forced conversion

The call for redemption of a convertible security at a price lower than the market value of the underlying asset into which the convertible may be exchanged. The investor finds it more favorable to exchange the convertible for the underlying asset than to give up the security for cash at the call price. For instance, suppose a $1,000 principal bond with a call price of $1,080 is converted into 20 shares of stock selling at $70 each. The bond is worth $1,400 in underlying stock. If the issuer calls the bond, the investor will be forced to convert before the call becomes effective.

Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.