The Handbook of Convertible Bonds: Pricing, Strategies and Risk Management (The Wiley Finance Series) by Schoutens Wim & De Spiegeleer Jan

Author:Schoutens, Wim & De Spiegeleer, Jan [Schoutens, Wim]
Language: eng
Format: mobi
Publisher: Wiley Publishing
Published: 2011-07-07T16:00:00+00:00

The best way to illustrate this is through a numerical example. This example is constructed around a 5-year convertible bond with a face value of 100. This convertible can be converted into one underlying share only. The spot price of the share is 100 and its volatility is 20%. To make matters even more clear, the convertible pays no coupon. It's hard to imagine an easier convertible to price. The convertible is also priced in a zero-interest rate environment. This assumption of r = 0 results in the fact that money has no longer any time value. As an investor you are, in such a world, indifferent between receiving a dividend tomorrow, next week or next year. This is the goal of the simulation we are going to do. Suppose we expect the underlying share to distribute one single dividend payout during the life of the convertible bond. The expected payout (D) is 20. This is a cash distribution which is equal to a dividend yield of 4.46% Equation (7.51). The dividend yield does not change whatever happens to the date of the dividend payout. As long as it is before the maturity date of the convertible bond, its level remains constant. In the following exercise, we will gradually move the ex-dividend date from six months after the pricing date to immediately before the expiry date of the bond. This allows us to study the timing impact of the dividend payout and its corresponding effect on the convertible price. The dividend yield model will, as expected, produce the same convertible bond price whatever the ex-dividend date might be.

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