CFA Level I · CFA Level I Exam · Fixed-Income Cash Flows and Types
A bond issued by a manufacturer can be exchanged by the bondholder for a fixed number of the issuer's ordinary shares. The bond's yield, compared with that of an otherwise identical non-convertible bond, is most likely:
The convertible bond's yield is most likely lower. The conversion option benefits the bondholder, who pays for it with a higher price, so the bond offers a lower yield or coupon than an otherwise identical non-convertible bond.
- Ahigher, because conversion adds credit risk
- Blower, because the investor holds a valuable optionCorrect
- Cidentical, because the coupon is fixed
Explanation
The conversion option favors the bondholder and has positive value. The investor pays for it through a higher price, so the yield or coupon is lower than on a straight bond. Conversion does not add credit risk in itself.
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