Question

Which one of the following statements concerning convertible bonds is false? Multiple Choice A convertible bond is similar to a bond with a call option. Som A convertible bond should always be worth less than a comparable straight bond. ences New shares of stock are issued when a convertible bond is converted, A convertible bond can be redeemed just like a straight bond at maturity. A convertible bond can be described as having upside potential with downside protection.

Answer 1

The Convertible bonds are like other types of bonds, convertible bonds have set maturity dates and they generally have fixed coupon rates. What makes them different is the conversion option, and each bond has its own conversion ratio. This is the number of shares of common stock the bond can be converted into.

Here the second statement is false as the convertible bond is more valuable than a straight bond, because the convertible can be considered to consist of 2 securities—the straight bond and a call option to buy company stock for the conversion price. If the stock price is below the conversion price, then the option only has time value, making the convertible bond only a little more valuable than the straight bond. As the stock price increases, the call option becomes more valuable. As the stock price increases above the conversion price, the bond price moves proportionately higher. The convertible bond value is always a little greater than the conversion value, because the bond provides some protection against a stock price decline. If the stock declines below the conversion value, then the bond still has worth as a straight bond.