Pricing Inflation-Indexed Convertible Bonds with Credit

49 Pages Posted: 3 Nov 2008  

Yoram Landskroner

Hebrew University of Jerusalem - Department of Finance and Banking; New York University (NYU) - Leonard N. Stern School of Business

Alon Raviv

Bar-Ilan University - Graduate School of Business Administration

Date Written: October 2002

Abstract

Issuing convertible bonds has become a popular way of raising capital by corporations in the last few years. An important subgroup is convertibles linked to a price index or exchange rate. The valuation model of inflation-indexed (or equivalently foreign-currency) convertible bonds derived in this paper considers two sources of uncertainty allowing both the underlying stock and the consumer-price-index to be stochastic and incorporates credit risk in the analysis. We approximate the pricing equations by using a Rubinstein (1994) three-dimensional binomial tree, and we describe the numerical solution. We investigate the sensitivity of the theoretical values with respect to the characteristics of the issuer, the economic environment and the security's characteristics (number of principal payments). Moreover, we demonstrate the usefulness and the limitations of the pricing model by using inflation-indexed and foreign currency linked convertibles traded on the Tel-Aviv stock exchange.

Keywords: convertible bonds, credit spread, binomial tree, pricing, inflation

Suggested Citation

Landskroner, Yoram and Raviv, Alon, Pricing Inflation-Indexed Convertible Bonds with Credit (October 2002). NYU Working Paper No. FIN-02-048. Available at SSRN: https://ssrn.com/abstract=1294420

Yoram Landskroner (Contact Author)

Hebrew University of Jerusalem - Department of Finance and Banking ( email )

Mount Scopus
Jerusalem, 91905
Israel

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

Alon Raviv

Bar-Ilan University - Graduate School of Business Administration ( email )

The Graduate School of Business Administration
Ana and Max Web st
Ramat Gan
Israel

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