The Valuation of Inflation-Indexed and FX Convertible Bonds

47 Pages Posted: 29 Jan 2004

See all articles by Yoram Landskroner

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

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. In this paper we extend the convertible pricing models of Tsiveriotis and Fernandes (1998) and McConnell and Schwartz (1986) to the case of indexation of the promised payments of the convertible to a general price index or to the price of foreign exchange. The theoretical framework derived in this paper considers two sources of uncertainty: both the underlying stock price and the consumer-price-index (or equivalently foreign-currency) are stochastic, and incorporate credit risk in the analysis. The extensions of two models enable to establish upper and lower bounds for the price of the indexed convertible. We approximate the pricing equations by using Rubinstein (1994) three-dimensional binomial tree, and we describe the numerical solution. We investigate and compare the models with respect to the characteristics of the issuer and the economic environment. Moreover, we demonstrate the usefulness and the limitations of the pricing model by using convertible traded on the Tel-Aviv stock exchange.

Keywords: Convertible bonds, credit spread, pricing, inflation, foreign exchange

JEL Classification: G12, G13, G15

Suggested Citation

Landskroner, Yoram and Raviv, Alon, The Valuation of Inflation-Indexed and FX Convertible Bonds. Available at SSRN: https://ssrn.com/abstract=490102 or http://dx.doi.org/10.2139/ssrn.490102

Yoram Landskroner

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
Suite 9-160
New York, NY NY 10012
United States

Alon Raviv (Contact Author)

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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