A General Method for Valuing Complex Capital Structures

Abstract

We develop a numerical method based on the Cox et al. (1979) binomial tree option valuation approach that can accommodate arbitrarily complex capital structures with varying debt maturities and seniorities, as well as preferred stock and warrants. The method provides straightforward valuation for common bond market features such as convertibility and prepayment options, as well as sinking fund provisions, that have proven challenging to model analytically.

Keywords: Capital Structure, Binomial Trees, Derivatives Pricing

JEL Classification: G12, G13, G32