Abstract:

Convertible bonds and exchangeable bonds are nearly the most complicated fixed income products which have much more exotic options. In all designable factors, the redemption clause and the selling back clause are the most flexible. What effect will they bring to the convertible bonds value under different design? Based on least squares Monte Carlo simulation method and common random number method, this paper deeply studies this problem from multi aspects. Furthermore, considering the differences between convertible bonds and exchangeable bonds, we also research what effect will have on the convertible bonds value and the options exercise status by the equity value dilution caused by exercising transfer equity option. The empirical study shows that although the probability of redemption is small, the call provision can significantly reduce the conversion period and raise the probability of conversion, thus decreasing the value of convertible bonds. Among all the factors of call provision, conversion triggering ratio and lock-up period have the greatest impact on early conversion, followed by redemption triggering period. Unlike the call provision, it is highly possible that the convertible bonds may be sold back without taking the conversion provision into consideration. Therefore, in order to reduce the possibility of early repayment, the conversion amendment provision is paramount. However, the put provision only has greater effect on its own exercise characteristics, which in turn affects the value of convertible bonds, and has little effect on the exercise characteristics of redemption and conversion. On the other hand, the proportion of dilution has linear effect on the value of convertible bonds. The larger the dilution proportion, the lower the value of debt-to-equity swap, the lower the value of the convertible bonds. However, the dilution has little effect on the probability and the time of the three options exercise.

Key words: convertible bonds options clauses design, least squares Monte Carlo, equity dilution effect