[According to the PRMIA study guide for Exam 1, Simple Exotics and Convertible Bonds have been excluded from the syllabus. You may choose to ignore this question. It appears here solely because the Handbook continues to have these chapters.]

[According to the PRMIA study guide for Exam 1, Simple Exotics and Convertible Bonds have been excluded from the syllabus. You may choose to ignore this question. It appears here solely because the Handbook continues to have these chapters.]

Which of the following statements relating to convertible debt are true:

I. A hard call protection means the bond cannot be called by the issuer till the share price reaches a threshold

II. It is advantageous for the issuer to call its convertible securities when the share price exceeds the conversion price

III. When the issuer’s share prices is very high, the convertible bond trades at a discount to the value of the shares it is convertible into

IV. Convertible bonds generally have to carry a higher coupon than on equivalent non-convertible securities to make them attractive to investors
A . III and IV
B . I and II
C . I, III and IV
D . II and III

View Answer

Answer: D

Explanation:

A ‘hard call protection’ means the bond cannot be called until a certain date, regardless of what the share price is. Therefore statement I is false. Also note that a ‘soft call protection’ means that a bond can be called only if the share price reaches a certain threshold.

It is advantageous for the issuer to call its convertible securities when the share price exceeds the conversion price – because these shares can instead be sold in the market at the higher share price than the lower conversion price. Statement II is true.

When the issuer’s share price is very high, the convertible bond trades at a discount to the share price because it is almost certain to be called by the issuer and be redeemed at par. Therefore statement III is right. Statement IV is incorrect because convertible bonds need to pay less coupon than equivalent non-convertible bonds because of the value of the option embedded in them.