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2.3 Convertible bonds
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A convertible bond has many features of a regular bond with payment
of coupons at regular intervals, except that the holder has the right
anytime to exchange the principal for a given asset.
When it reaches maturity at time
, the convertible bond returns an
amount
unless the owner has converted the bond into
shares of
the underlying with a total value
. Immediately before maturity,
the payoff is described by
|
(2.3#eq.1) |
Although the terminal payoff in (2.3#fig.1) does not
present much difficulty, the valuation of a convertible bond before
the expiry is substantially complicated by the long time spans under
consideration: a proper model involves two imperfectly correlated
random variables describing fluctuations in the stock
and
bond prices
.
Figure 2.3#fig.1:
Terminal payoff diagram for a convertible bond with a principal
as a function of possible realizations of the underlying share price
.
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SYLLABUS Previous: 2.2.4 Bond options: caps,
Up: 2 A VARIETY OF
Next: 2.4 Hedging parameters, portfolio