Chartered Institute of Stockbrokers (CISI) Professional Practice Exam

Which of the following is an essential characteristic of a convertible bond?

1. Fixed dividends

2. Tranferable ownership

3. Convertibility into equity shares

4. Tax advantages

The correct answer is: Convertibility into equity shares

A convertible bond is a type of debt security that gives bondholders the right to convert their bonds into a predetermined number of the issuing company's equity shares, usually at specific times during the bond’s life. This convertibility feature is the hallmark of convertible bonds and reflects their dual nature, allowing investors to take advantage of both fixed income and equity appreciation potential. When considering this characteristic, it becomes clear that the ability to convert a bond into equity is what distinguishes convertible bonds from other types of bonds, which tend to offer fixed interest payments and do not have a conversion feature. This flexibility attracts investors who are looking for growth potential while still having the safety net of fixed income. In contrast, fixed dividends are typically associated with preferred shares rather than bonds, transferable ownership relates to many types of securities but does not uniquely define convertible bonds, and tax advantages can vary depending on the jurisdiction and type of investment, thus are not a defining feature of convertible bonds. The essence of convertible bonds lies in their ability to be converted into equity shares, making their convertibility the key characteristic.