Question

convertible bonds normally have to permit the issuer to retire or encourage conversion

a) a put option

b) a call feature

c) a stock purchase warrant

d) a striking price

Answer 1

To answer this we need to understand what a convertible bond is. It is essentially a type of option given to the holders to convert the security into predetermined number of common stock. If I am holding a convertible bond, I treat it as a bond by which I continue to receive coupon payments, but I also have an option to convert it into stock later. As this conversion has value for holders, normally such securities pay lower coupon payments or are priced higher.

Think of Convertible bond as a straight bond and also embedded in it is a call option to buy stock at a predetermined price, called conversion price. As the stock price increases, this option becomes more valuable.

Hence, the option is B. Call feature.

A. Is wrong as put is not embedded. We do not sell. We convert bond by buying stock

C. Also wrong for reasons explained above.

D. Not relevant.