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?
Correct Answer C. Both 1 and 2
Explanation
Correct answer: (c) Both 1 and 2
A convertible bond is hybrid debt-equity paper. Statement 1 is correct: because investors value the option to convert into equity, issuers can offer a lower coupon rate than on an ordinary bond. Statement 2 is correct: since equity values tend to move with rising prices, the conversion option gives the bondholder a natural hedge against inflation.