Pricing Foreign-Currency Convertible Bonds And Call on Foreign-Currency Convertible Bonds Subject to Credit Risk

Abstract

This paper is the first article to price foreign-currency (or inflation-indexed) convertible bonds and their asset swaps under the consideration of risk-free and risky interest rates, stock price, exchange rate, and credit risk. We also compute the suitable swap rate for asset swap and prove that the value of a foreign-currency convertible bond is less than (equal to) the value of a synthesis straight bond plus the value a call option on foreign-currency convertible bond while the foreign-currency convertible bond is (not) embedded with the call or put provisions prior to the maturity date of asset swap. In practice, the value of a call on foreign-currency convertible bond is equal to the value of a foreign-currency convertible bond minus the value of a synthetic straight bond. It is correct only if there is not call or put provisions prior to maturity date of FCCB asset swap. From numerical analysis, we also discover the properties of foreign-currency convertible bonds, synthesis straight bonds, call options on foreign-currency convertible bonds, and the swap rate. Taking the foreign-currency convertible bond issued by Tom holdings Ltd as an example, we provide the theoretical values of the foreign-currency convertible bond, call option on foreign-currency convertible bond and the appropriate swap rate. The empirical results indicate that the numerical value is closed to the market price. Hence, our pricing model is useful for market practitioners.