Which of the following statements about convertibles is most CORRECT?
A) One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted.
B) Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt.
C) At the time it is issued, a convertible's conversion (or exercise) price is generally set equal to or below the underlying stock's price.
D) For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock.
E) The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise similar straight debt.

Question

Quizplus · Accepted Answer

For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock. This is because a convertible bond holder has the option to convert the bond into shares of the company's common stock, which offers the potential for capital gains if the stock price rises. This potential for higher returns means that the expected return on a convertible bond is generally higher than that of straight debt, but lower than that of common stock.

Which of the Following Statements About Convertibles Is Most CORRECT