"Fixed Income":Yield of bonds without options
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Questions 1:
Consider two 10-year bonds, one that contains no embedded options and the other that gives its owner the right to convert the bond to a fixed number of shares of the issuer’s common stock. The convertibility option in the second bond cannot be exercised for five years. The bonds are otherwise identical. Compared with the yield on the convertible bond, the yield on the option-free bond is most likely:
A 、the same.
B 、lower.
C、 higher.
Questions 2:
What type of risk most likely affects an investor’s ability to buy and sell bonds in the desired amounts and at the desired time?
A、 Market liquidity
B 、Spread
C 、Default
C is correct. The convertibility option provides a benefit to the investor, who will accept a lower yield on the convertible bond compared with the option-free bond.
A is incorrect because the yield on the option-free bond will be higher.
B is incorrect because the yield on the option-free bond will be higher.
A is correct. The size of the spread between the bid price and the ask price is the primary measure of market liquidity of the issue. Market liquidity risk is the risk that the investor will have to sell a bond below its indicated value. The wider the bid–ask spread, the greater the market liquidity risk.
B is incorrect because spread risk is the risk that spreads widen.
C is incorrect because default risk is the risk the borrower defaults.
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