UPSC Prelims 2022 · Question 65 of 98
UPSC Prelims 2022 question on Convertible Bonds
- ExamUPSC CSE
- Year2022
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicImportant Economic Concepts
- DifficultyMedium
- TypeStatement
With reference to Convertible Bonds, consider the following statements:
1. As there is an option to exchange the bond for equity, Convertible Bonds pay a lower rate of interest.
2. The option to convert to equity affords the bondholder a degree of indexation to rising consumer prices.
Which of the statements given above is/are correct?
Show answer
Answer: C. Both 1 and 2
Verdict
Both statements are correct → Option (c) Both 1 and 2.
Statement by statement
Statement 1 – CORRECT: A convertible bond is a fixed-income corporate debt security that can be converted into a predetermined number of common stock or equity shares. Convertible bonds tend to offer a lower coupon rate or rate of return in exchange for the value of the option to convert the bond into common stock. Hence statement 1 is correct.
Statement 2 – CORRECT: The option to convert to equity affords the bondholder a degree of indexation to rising consumer prices. As indexation will ensure that prices are adjusted with inflation over a period of time, bondholders will be able to lower their long-term capital gains (as their investment will be adjusted with inflation) even when converting bonds into equity, which brings down their taxable income. Hence statement 2 is correct.