Abstract
This chapter discusses the pricing and valuation of convertible bonds. The chapter presents a model that incorporates the likelihood of the option feature being exercised during the life of a bond. The current analytical approach for the convertible bond valuation considers the instrument as a conventional vanilla bond as well as an embedded option. When a convertible bond is converted into the underlying shares, new shares are issued. The chapter reviews the pricing model that assumes a constant volatility level for the price returns of the underlying equity. Virtually all convertible bonds are issued by corporates and therefore expose their holders to an element of default risk. Rating agencies assign a formal credit rating to the individual issue of a corporate. For deeply out-of-the-money convertibles, the yield may be taken to be equivalent to a conventional bond, and therefore it is possible to view the theoretical spread directly.
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