Assume a firm issues convertible bonds at a time when the risk of the firm is difficult to properly assess.If the firm is subsequently determined to have low risk,then the:
A)straight bond component of the convertible bond will have high value.
B)bond should be immediately converted.
C)conversion value will always exceed the straight bond value.
D)call option of the convertible bond will have high value.
E)the firm will eliminate the conversion option.

Question

Quizplus · Accepted Answer

If the firm is determined to have low risk, the overall value of the convertible bond will increase, including the straight bond component. This is because the lower risk profile of the firm will make the bond less risky, which will increase its value. However, it is unlikely that the bond should be immediately converted, as this decision would be based on a variety of factors such as the stock price and the conversion ratio. The conversion value may or may not exceed the straight bond value, depending on market conditions. Similarly, the call option value may or may not be high depending on the situation. It is unlikely that the firm would eliminate the conversion option, as this would decrease the attractiveness of the bond to investors.

Assume a Firm Issues Convertible Bonds at a Time When