Question Financial Derivative Pricing : Convertible Bonds Strike Adjustments

[bcampana]

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

• 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

My Question: If I price the convertible bond today, should I adjust the option strike price?

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: