What it means
The farm meaning grew out of American agricultural policy. Policymakers in the 1930s wanted a benchmark for a fair farm price, and they chose purchasing power: what a bushel of wheat could buy in goods and services.
The parity price is that benchmark updated for inflation. It takes the base-period price, from 1910 to 1914 for many commodities, and multiplies it by how much prices of things farmers buy have risen since.
The US Department of Agriculture's National Agricultural Statistics Service still computes and publishes parity prices each month, with the method set out in its guide to agricultural price statistics. The ratio of actual prices received to parity, called the parity ratio, shows how farm purchasing power is faring.
Modern farm support no longer pegs prices to full parity, but the measure survives in legislation and as a historical yardstick in debates about farm incomes. The convertible-bond meaning is simpler.
A convertible bond can be exchanged for a set number of shares, so its parity price is the market value of those shares, the floor value the bond would have if conversion happened immediately. Traders compare a convertible's market price with its parity price.
A bond trading below parity offers an arbitrage opportunity, because buying the bond and converting captures the share value for less than it costs in the market. The two uses share one root idea: a reference value that keeps one thing in line with another.
For farmers it is income keeping pace with costs; for bondholders it is the bond keeping pace with the shares behind it. For a non-finance reader, parity price is a fairness ruler.
In both farming and convertibles, it measures whether the thing you hold is keeping up with the thing it is supposed to track.
In practice
Real-world examples.
Example
A dairy lobby cites a parity ratio of 40% to argue that milk prices buy far less feed, fuel, and equipment than they did in the base period. The figure is used as a rhetorical benchmark in a policy debate, not as a guaranteed support level.
Example
A convertible bond with a 25-share conversion ratio has a parity price of $750 when the stock trades at $30, and traders watch for the market price to approach that floor. If the share price rises to $34, parity rises to $850 and the bond's price is pulled upward with it.
Example
An arbitrage desk buys a convertible trading below parity and hedges by shorting the underlying shares, locking in the gap as the prices converge. The strategy depends on the bond and the shares being close enough in price that the gap is not eroded by costs or credit concerns.
Formula
Calculation
Farm parity price equals the base-period price multiplied by the parity index, which tracks prices paid by farmers for production and living items, divided by 100. Convertible parity price equals the number of shares per bond multiplied by the current share price.
Farm worked example: suppose the base-period wheat price was $0.80 a bushel and the parity index stands at 1,500. Parity price = $0.80 x 1,500 / 100 = $0.80 x 15 = $12.00 a bushel. If farmers actually receive $6.00, the parity ratio = $6.00 / $12.00 = 50%.
Convertible worked example: a bond converts into 40 shares and the stock trades at $25. Parity price = 40 x $25 = $1,000. If the bond trades at $1,060, the conversion premium is $1,060 - $1,000 = $60, which is 6% of parity.Case study
Seen in the real world.
This case study is fictional and illustrative. The made-up Heartland Grain Cooperative tracks parity each season when advising members. In 1930s terms its base wheat price was about one dollar a bushel, and the current parity index has multiplied that benchmark many times over as input and living costs rose.
This year the computed parity price sits near $13 a bushel while the market pays 7, so the parity ratio is around 54 percent. The cooperative uses the figure in its submission to a farm-policy hearing, arguing that growers' purchasing power has nearly halved against the historic standard. Separately, its treasurer watches a convertible bond in the pension fund: with a conversion ratio of 20 shares and the stock at $42, parity is $840, so the bond's quoted price of 860 leaves a modest conversion premium she considers fair.
Watch out
Common mistakes.
- Treating the farm parity price as a guaranteed support level; modern programmes rarely guarantee full parity, so the figure is a benchmark, not a floor.
- Confusing the two meanings of parity price, since the farm-policy benchmark and the convertible-bond value answer completely different questions.
- Assuming a convertible trading at parity is automatically cheap, because time value, credit risk, and call features can justify prices above or below the conversion value.
Questions
People also ask.
Why was the base period 1910 to 1914 chosen?
Those years were viewed as a time when farm and non-farm prices were in a healthy balance, so legislators adopted them as the fairness benchmark for farm purchasing power.
Is the parity price still used in US farm policy?
It survives in statutes and USDA publications as a reference measure, but actual support programmes today use other mechanisms rather than guaranteeing parity.
How do you compute parity for a convertible bond?
Multiply the bond's conversion ratio, the shares receivable per bond, by the current share price; the result is the value of converting immediately.
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