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 indexa

examrobotsa's picture

Submitted by examrobotsa on

Q: 65 (IAS/2022)
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 ?

question_subject: 

Economics

question_exam: 

IAS

stats: 

0,142,61,21,33,142,7

keywords: 

{'convertible bonds': [0, 0, 0, 1], 'equity affords': [0, 0, 0, 1], 'equity': [0, 1, 1, 5], 'bond': [0, 0, 2, 4], 'consumer prices': [0, 0, 0, 2], 'bondholder': [0, 0, 1, 1], 'indexation': [0, 0, 0, 1]}

Statement 1 is correct because Convertible Bonds offer an option to bondholders to convert the bond into equity at a pre-determined price, which gives them the potential to benefit from any rise in the company's share price. This option to convert the bond into equity makes the bonds more attractive to investors, and hence the issuer can offer a lower rate of interest.

Statement 2 is also correct because as the bondholder has the option to convert the bond into equity, the value of the bond tends to track the price of the underlying equity. Hence, in a rising inflationary environment, the value of the equity may also rise, which can provide a degree of indexation to rising consumer prices to the bondholder.

 

Preparing for Future Exams: Learning from the Analysis of Past Questions

Topics:

  • Bonds and securities
  • Convertible bonds
  • Interest rates
  • Equity
  • Inflation

Sources:

NCERT and reference book chapters:

  • Class 12 NCERT Economics: Chapter 3 - Money and Banking
  • Macroeconomics by N. Gregory Mankiw: Chapter 26 - Saving, Investment, and the Financial System
  • Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, and Franklin Allen: Chapter 17 - Debt Financing

Related concepts:

  • Bond valuation
  • Yield to maturity
  • Conversion ratio
  • Call and put options
  • Dilution
  • Nominal and real interest rates