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The Valuation of Inflation-Indexed and FX Convertible Bonds

Author

Listed:
  • Yoram Landskroner

    (Hebrew University)

  • Alon Raviv

    (Hebrew University)

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, the economic environment and the security’s characteristics. Moreover, we demonstrate the usefulnes and the limitations of the pricing model by using convertible traded on the Tel- Aviv stock exchange.

Suggested Citation

  • Yoram Landskroner & Alon Raviv, 2004. "The Valuation of Inflation-Indexed and FX Convertible Bonds," Finance 0401005, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0401005
    Note: Type of Document - ; pages: 49
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    References listed on IDEAS

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    Cited by:

    1. Kanas, Angelos, 2014. "Bond futures, inflation-indexed bonds, and inflation risk premium," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 28(C), pages 82-99.
    2. Jonathan A. Batten & Karren Lee-Hwei Khaw & Martin R. Young, 2014. "Convertible Bond Pricing Models," Journal of Economic Surveys, Wiley Blackwell, vol. 28(5), pages 775-803, December.
    3. Bakke, Ida & Fleten, Stein-Erik & Hagfors, Lars Ivar & Hagspiel, Verena & Norheim, Beate, 2016. "Investment in mutually exclusive transmission projects under policy uncertainty," Journal of Commodity Markets, Elsevier, vol. 3(1), pages 54-69.

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    More about this item

    Keywords

    Convertible Bonds; Credit Spread; Pricing; Inflation; Foreign- Exchange;
    All these keywords.

    JEL classification:

    • G - Financial Economics

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