Which of the following statements is true of convertible bonds?
A) The most significant disadvantage to a corporation of issuing convertible bonds is that they increase the cash that the firm must use to make interest payments.
B) The typical conversion ratio is set so that the firm's stock price must appreciate 5% or less before it is profitable for the holder to convert the bond to stock.
C) Firms that issue convertible bonds can do so at a lower interest rate.
D) The typical issue of convertible bonds allows the holder of the bond to convert it to preferred stock.

Question

Quizplus · Accepted Answer

Firms that issue convertible bonds can typically do so at a lower interest rate than traditional bonds because the option to convert the bond to stock acts as a form of equity financing. A is incorrect as convertible bonds do not necessarily increase the cash that the firm must use to make interest payments. B is incorrect as the conversion ratio is unique to each issuance and is typically set based on market conditions at the time the bonds are issued. D is incorrect as the typical option for conversion in convertible bonds is to common stock, not preferred stock.

Which of the Following Statements Is True of Convertible Bonds