Certified Anti-Money Laundering Specialist Certification (CAMS) Practice Exam

What characterizes a convertible bond?

1. It can be converted into cash after maturity

2. It grants a fixed interest rate for its entire term

3. It gives the holder an option to convert to other securities

4. It is unsecured and has a lower interest rate

The correct answer is: It gives the holder an option to convert to other securities

A convertible bond is characterized by its ability to provide the holder with the option to convert the bond into a predetermined number of the issuing company's equity shares or other securities. This feature allows investors to potentially benefit from the company's growth and capital appreciation, offering an opportunity to convert when the market conditions are favorable. In contrast, merely converting a bond into cash after maturity is not an option; the bondholder typically receives the face value upon maturity. Additionally, while a fixed interest rate is a common feature of many bonds, it does not specifically define a convertible bond. Lastly, while some convertible bonds can indeed be unsecured or have lower interest rates, these aspects do not capture the defining trait of the bond's convertibility into equity. The ability to transition into another form of investment, specifically equity, is what sets convertible bonds apart within the investment landscape.