With reference to Convertible Bonds, consider the following statements: 1. As there is an option to exchange…
With reference to Convertible Bonds, consider the following statements: 1. As there is an option to exchange the bond for equity, Convertible Bonds pay a lower rate of interest. 2. 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
Solution
Convertible bonds pay lower interest because the conversion option has value. Conversion to equity provides indirect inflation hedging since equities tend to rise with inflation.