Q65.
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?
Answer
C
Explanation
Statement 1 is correct: Convertible bonds tend to offer a lower coupon rate or rate of return in exchange for the value of the option to convert the bond into common stock. Companies benefit since they can issue debt at lower interest rates than with traditional bond offerings. Statement 2 is correct: The option to convert to equity affords the bondholder a degree of indexation to rising consumer prices, as indexation ensures prices are adjusted with inflation over time, helping bondholders lower their long-term capital gains when converting bonds into equity.