SIE practice questionmediumPreferred Stock — Convertible Feature
An investor holds convertible preferred stock with a conversion ratio of 4:1 (4 shares of common for each preferred share). If the preferred stock is trading at $120 and common stock at $25, the preferred is trading at:
- AA premium to its conversion value✓ Correct answer
- BCannot be determined without knowing the par value
- CParity with its conversion value
- DA discount to its conversion value
Explanation
Why A — A premium to its conversion value
Conversion value = conversion ratio x common stock price = 4 x $25 = $100. The preferred is trading at $120, which is $20 above its conversion value of $100, so it trades at a premium. This premium reflects the preferred stock's dividend advantage and downside protection relative to common stock.
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