The Eurobond market for convertible bonds and solutions to selected valuation problems
The Eurobond market for convertible bonds and solutions to selected valuation problems
The Eurobond Market for corporate debt is estimated to exceed $2,000bn worth of corporate and mortgage-backed bonds, of which there is approximately one eighth with complex equity-linked features, more commonly known as convertible bonds. This thesis is directed towards analysing the nature of these securities and proposing solutions for selected valuation problems associated with them. The work leans heavily on option pricing theory and spans subjects associated with both equity derivatives and risky debt.
The thesis starts with a detailed analysis of the features of convertible bonds. The ever-increasing complexity of these financial contracts make them one of the most demanding valuation problems in finance.
Valuation challenge associated with complex securities are addressed by developing the decomposition approach that offers benefits in understanding the nature of the security as well as offering a simplified valuation approach. I take callable and puttable zero-coupon convertible bonds, known as Liquid Yield Option Note, and present a methodology for stripping it into a portfolio of callable zero coupon bond, callable option-to-convert, and callable option-to-put. In addition, the issuer’s requirement to give a notice prior to exercising its option-to-call is specifically added to the decomposition. Its positive value to the bondholder is also a reason for an issuer to delay exercising its call in order to minimise agency costs associated with refinancing and reduce the underwriting risk.
The overwhelming majority of stocks underlying the convertible bonds that trade in the Eurobond Market pay regular dividends. The inertia towards using simplified dividend modelling by assuming stocks are paying continuous dividend yields (or an constant yield on particular dates) can result in significant pricing errors even for short dated call options, and especially when the cumulative amount of distributed dividend is a significant proportion of the initial stock price.
University of Southampton
Jevtić, Branko Z
66105ad1-6e49-4ca1-a785-6b70e65df668
2003
Jevtić, Branko Z
66105ad1-6e49-4ca1-a785-6b70e65df668
Jevtić, Branko Z
(2003)
The Eurobond market for convertible bonds and solutions to selected valuation problems.
University of Southampton, Doctoral Thesis.
Record type:
Thesis
(Doctoral)
Abstract
The Eurobond Market for corporate debt is estimated to exceed $2,000bn worth of corporate and mortgage-backed bonds, of which there is approximately one eighth with complex equity-linked features, more commonly known as convertible bonds. This thesis is directed towards analysing the nature of these securities and proposing solutions for selected valuation problems associated with them. The work leans heavily on option pricing theory and spans subjects associated with both equity derivatives and risky debt.
The thesis starts with a detailed analysis of the features of convertible bonds. The ever-increasing complexity of these financial contracts make them one of the most demanding valuation problems in finance.
Valuation challenge associated with complex securities are addressed by developing the decomposition approach that offers benefits in understanding the nature of the security as well as offering a simplified valuation approach. I take callable and puttable zero-coupon convertible bonds, known as Liquid Yield Option Note, and present a methodology for stripping it into a portfolio of callable zero coupon bond, callable option-to-convert, and callable option-to-put. In addition, the issuer’s requirement to give a notice prior to exercising its option-to-call is specifically added to the decomposition. Its positive value to the bondholder is also a reason for an issuer to delay exercising its call in order to minimise agency costs associated with refinancing and reduce the underwriting risk.
The overwhelming majority of stocks underlying the convertible bonds that trade in the Eurobond Market pay regular dividends. The inertia towards using simplified dividend modelling by assuming stocks are paying continuous dividend yields (or an constant yield on particular dates) can result in significant pricing errors even for short dated call options, and especially when the cumulative amount of distributed dividend is a significant proportion of the initial stock price.
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Published date: 2003
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Local EPrints ID: 464930
URI: http://eprints.soton.ac.uk/id/eprint/464930
PURE UUID: 540e0315-8633-45ec-99f1-8aef8cc9cfa3
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Date deposited: 05 Jul 2022 00:12
Last modified: 16 Mar 2024 19:50
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Author:
Branko Z Jevtić
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