Dear peeps,
In the curriculum, it is said that a convertible bond functions the same as a Bond + a set of call options (The set consisting of the number related to the conversion ratio - I assume that the strike price of these call options is equal to the conversion price = issue price / conversion Ratio). I am confused about this for the following reason: If you own a bond, you stand to gain/lose from the appreciation/depreciation of the bond (interest rate risk); therefore, with a Bond and a set of call options, you would stand to potentially earn both the appreciation of the bond price above the purchase price as well as the appreciation of the stock above the conversion/strike price of the options (think about it - if the value of the bond increases, you could sell the bond, use part of the proceeds to exercise your call options, and then still have some proceeds left over). In contrast, from what I understand, with a convertible bond, in order to convert the bond to stock the borrower simply dissolves the debt contract and provides stock to the lender. Therefore, with a convertible bond, you would only stand to gain from the potential appreciation of the stock price above the conversion price/strike price.
Please note - In order to simplify the question, I ignored the coupon payments that would arise from either portfolio - the bond + call options or the convertible bond.