ShooterMcCFA

Suppose that the stock price of a common stock increases by 10%. Which of the following is most accurate for the price of the recently issued convertible bond? The value of the convertible bond will:

A) increase by 10%.

B) increase by less than 10%.

C) remain unchanged.

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When the underlying stock price rises, the convertible bond will underperform because of the conversion premium.

ShooterMcCFA

How do the risk-return characteristics of a newly issued convertible bond compare with the risk-return characteristics of ownership of the underlying common stock? The convertible bond has:

A) lower risk and higher return potential.

B) higher risk and higher return potential.

C) lower risk and lower return potential.

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Buying convertible bonds in lieu of direct stock investing limits downside risk due to the price floor set by the straight bond value. The cost of the risk protection is the reduced upside potential due to the conversion premium.