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- Title
ANALYTICS OF DURATION AND CONVEXITY FOR BONDS WITH EMBEDDED OPTIONS: THE CASE OF CONVERTIBLES.
- Authors
Mehran, Jamshid; Homaifar, Ghassem
- Abstract
Most recent advances in the application of duration and convexity to bond valuation focus on option free bonds or the so-called 'plain vanilla' variety. But, as yet, no one has provided an adequate analytical formulation of duration and convexity for convertible bonds. The price behavior of a convertible bond differs from a nonconvertible bond, because the convertible's price reflects the underlying value of the issuing firm's common stock, as well as changes in market interest rates. As noted by Yawitz (1988), a convertible bond possesses greater positive convexity than a comparable callable bond because of the inclusion of the call option. This unique feature of convertibles makes their cash flows and maturities uncertain and thus, the simple duration- convexity of a pure bond is an insufficient proxy for the duration- convexity of a convertible bond. Presented in this study is a method for estimating duration and convexity for convertible bonds. Furthermore, the measures of duration and convexity for convertible bonds developed in this paper provide a testable hypothesis about the timing of a company's exercise of its call option on convertible debt.
- Publication
Journal of Business Finance & Accounting, 1993, Vol 20, Issue 1, p107
- ISSN
0306-686X
- Publication type
Academic Journal
- DOI
10.1111/j.1468-5957.1993.tb00253.x