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?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans: c
Explanation:
What Is a Convertible Bond?
- Convertible bonds are powerful financial instruments that effectively combine the advantages of both bonds and stocks. These fixed-income securities not only provide regular interest payments but also grant investors the right to convert their bonds into a specified number of company shares, enabling them to directly participate in the company’s growth. When a company’s stock performs strongly, the value of convertible bonds can rise significantly, offering a robust hedge against inflation.
- Investors can strategically choose to convert their bonds into shares at a predetermined time, with specific conversion terms laid out at the bond’s issuance. This feature empowers investors to earn consistent interest while also taking advantage of potential stock price surges. Consequently, convertible bonds generally come with lower interest rates compared to traditional corporate bonds, reflecting the valuable option to convert into equity shares.
- Convertible bonds are also often traded on secondary markets, meaning investors can choose to buy or sell them before maturity.However, the liquidity of each of these types of bonds may be dramatically different depending on the issuer’s credit rating and prevailing market conditions.
Hence, statements 1 and 2 are correct.
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