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Company MNL holds a CONVERTIBLE BOND that lets it convert the bond into the ordinary shares of Company Z. Identify the host contract and the embedded derivative.
AHost = Z's ordinary shares; embedded derivative = MNL's option to refuse conversion
BBoth legs are derivatives — the bond and the conversion option each independently
CHost = the conversion option; embedded derivative = the bond principal repayment
DHost = bond asset (debt); embedded derivative = the conversion option to convert into Z's shares
Answer & Solution
Correct answer: D. Host = bond asset (debt); embedded derivative = the conversion option to convert into Z's shares
In a convertible bond, the host is the straight debt instrument (predictable interest + redemption stream), and the conversion option (right to switch into Z's shares) is the embedded derivative. The conversion right modifies the bond's cash flows based on Z's equity price — variable specific to the underlying.
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