With reference to Convertible Bonds, consider the following statements:
- As there is an option to exchange the bond for equity, Convertible Bonds pay a lower rate of interest.
- The option to convert to equity affords the bondholder a degree of indexation to rising consumer prices.
Which of the statements given above is/are correct?
- 1 only
- 2 only
- Both 1 and 2
- Neither 1 nor 2
Explanation
Statement 1 is correct
- A convertible bond is a fixed-income corporate debt security that yields interest payments but can be converted into a predetermined number of common stock or equity shares. The conversion of the bond to stock can occur at certain times during the bond’s life and is usually at the bondholder’s discretion. Convertible bonds typically offer a lower interest rate compared to non-convertible bonds. This is because the bondholder is given the option to convert the bond into equity, which has potential upside benefits if the company’s stock price rises.
Statement 2 is correct
- Convertible bonds provide a degree of protection against rising consumer prices through their conversion feature. While they do not directly adjust for inflation, the potential for stock price appreciation can result in increased value for bondholders who convert their bonds into equity.
