Convertible Bonds: Model, Value Attribution, and Analytics

Thomas S.Y. Ho and David M. Pfeffer

Financial Analysts Journal, 1996, vol. 52, issue 5, 35-44

Abstract: Convertible bonds provide investors an option to convert the bond into the underlying equity. For this reason, a convertible bond is exposed to both equity and interest rate risk. Incorporating these two sources of risk into the model is particularly important for callable issues. In this study, a two-factor model is used to analyze a sample of bonds. The model shows that the correlation of stock risk and interest rate risk may affect convertible bond prices significantly. The bond pricing model also provides portfolio analytics and can decompose a convertible bond into its basic components—the stock and bonds with different maturities. This approach enables an investor to implement a more precise hedging strategy than is possible using only delta.

Date: 1996
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DOI: 10.2469/faj.v52.n5.2022

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