Hi everybody,
I'm currently seeking information regarding strike adjustments for convertible bonds pricing when the bond redemption value at maturity is above its initial nominal value.
In my case the convertible bond is a combination of a bond floor and an embeded american call option.
I used a simple methodology which consists in splitting the bond floor and the option value to determine the convertible bond price summing these two coponents.
Numerical example:
Bond issued 06/26/07
Maturity 06/26/11
Nominal PER:1000
Conversion ration 50
Spread: +350 bps
Redeem at: 112.5
Fixed Rate: 5%
Frequency of coupons: Annual
Details of my methodology
The strike price is supposed to be: 1000/50=20
But as the redemption value at maturity is equal to 112.5%, exercising the conversion option today means renouncing to the redemption value of the bond.
Therefore:
Should we consider this factor to adjust the strike price (1000*112.5% / 50=22.5)? and 22.5 becomes my new strike price? Which leads to a decrease in the option value ( but to be honnest I do not believe that it is a solution).
or
Should we consider this factor to adjust directly the option value by dividing OV by 112.5% (7%/1,125)?
or
Any other idea????
Thanks a lot for your help...
Bru:sos:
I'm currently seeking information regarding strike adjustments for convertible bonds pricing when the bond redemption value at maturity is above its initial nominal value.
In my case the convertible bond is a combination of a bond floor and an embeded american call option.
I used a simple methodology which consists in splitting the bond floor and the option value to determine the convertible bond price summing these two coponents.
Numerical example:
Bond issued 06/26/07
Maturity 06/26/11
Nominal PER:1000
Conversion ration 50
Spread: +350 bps
Redeem at: 112.5
Fixed Rate: 5%
Frequency of coupons: Annual
Details of my methodology
- Bond Floor (BF) computed by summing the present value of future cash flows. For the bopnd floor I considered the credit spread of the convertible bond issuer to determine the discount factors. BF = 83%
- Option value (OV) computed using Cox Rubinstein binomial model: OV = 7%.
- Convertible Bond Value = BF + OV
The strike price is supposed to be: 1000/50=20
But as the redemption value at maturity is equal to 112.5%, exercising the conversion option today means renouncing to the redemption value of the bond.
Therefore:
Should we consider this factor to adjust the strike price (1000*112.5% / 50=22.5)? and 22.5 becomes my new strike price? Which leads to a decrease in the option value ( but to be honnest I do not believe that it is a solution).
or
Should we consider this factor to adjust directly the option value by dividing OV by 112.5% (7%/1,125)?
or
Any other idea????
Thanks a lot for your help...
Bru:sos:
