Parity Price
Parity price refers to a price level that sets two assets or securities equal in value to one another. It is a concept that is used in several markets, including fixed income, equities, commodities, and convertible bonds. For convertible bonds, the parity price concept is used to determine when it is financially beneficial to convert a bond into shares of common stock.If two assets are trading at parity, it can be inferred they are at the same price or value.
Parity Price
Definition
Parity price refers to setting the value of two assets or securities at an equal price level. This concept is used in several markets, including fixed income, stocks, commodities, and convertible bonds. For convertible bonds, the parity price is used to determine when it is economically advantageous to convert the bond into common stock. If two assets trade at parity, it can be inferred that their prices or values are equal.
Origin
The concept of parity price originated in the early stages of financial market development, particularly in the fixed income and stock markets. As financial instruments diversified, the application of parity price expanded to commodity and convertible bond markets. Key events include the introduction of convertible bonds in the early 20th century and the development of arbitrage trading strategies in modern financial markets.
Categories and Characteristics
Parity price can be categorized into the following types:
- Fixed Income Parity: Used to compare the yields and prices of different bonds.
- Stock Parity: Used to compare the price levels of different stocks or stock indices.
- Commodity Parity: Used to compare the market prices of different commodities.
- Convertible Bond Parity: Used to determine when it is economically advantageous to convert a convertible bond into common stock.
Each type of parity price has different characteristics and application scenarios. For example, fixed income parity is mainly used for arbitrage trading in the bond market, while convertible bond parity is used by investors to decide whether to convert bonds.
Specific Cases
Case 1: Suppose an investor holds a convertible bond with a face value of $1,000, which can be converted into 50 shares of common stock. If the current market price of the common stock is $20, the parity price of the bond is $1,000 (50 shares * $20). If the stock price rises to $25, the parity price becomes $1,250, making it economically advantageous to convert the bond.
Case 2: In the commodity market, suppose the price ratio of gold to silver is usually 1:80. If the current gold price is $1,600 per ounce and the silver price is $20 per ounce, their parity prices are $1,600 and $20, respectively. If the silver price rises to $25 per ounce, investors might consider arbitrage trading.
Common Questions
Question 1: Does the parity price always accurately reflect the true value of assets?
Answer: The parity price is a theoretical concept, and actual market prices may be influenced by factors such as supply and demand and market sentiment.
Question 2: How is the parity price of a convertible bond determined?
Answer: The parity price of a convertible bond can be calculated by multiplying the number of shares the bond can be converted into by the current market price of the common stock.
