Pricing Options Embedded in Corporate Bonds Using the Binomial Method

The performance of existing financial products is an important issue in the capital market to increase the new products for reducing the risk of dependency on common stocks. The research aims are to evaluate the growth and development of existing financial instruments and to recommend for introducing new financial instruments in the capital market of Bangladesh. The data are taken from the Dhaka stock exchange for the year 1977 to 2010 for interpretation of development and the data from 2003 to 2010 are taken for analysis and hypothesis test. There are only five products traded including three types of bonds. The average growth rate of market capitalization of common stocks, treasury bonds, mutual funds, corporate bonds & debentures are 71.02%, 124.74%, 99.85% and 105.41% respectively. The growth of market capitalization of all products is high. There is lot of scope in the market for absorbing the new products. The share of common stocks, treasury bond, corporate bond, debentures, mutual funds to total market capitalizations are 87.73%, 12.25%, 0.24%,0.17% and 0.83% respectively. The market is common stock based. The corporate bond market is very small. So, there should be increased new financial instruments in the capital market to reduce the dependency on share only. The proposed financial instruments are various types of preferred stock, bond, SWAP, option, futures, and forwards as recommendation.

This engaging book offers a primer on stocks and bonds, using easy-to-understand language to explain how they function and why they are important. It will be a valuable resource for both economics students and readers interested in investing. Although news outlets provide daily updates on stock market performance, many Americans have little understanding of how stocks and stock exchanges work. Yet stocks, along with government and corporate bonds, represent two key cornerstones of modern economics. While the average American may think of them as simply two types of investments, stocks and bonds have impacts on the economy that go far beyond the realm of personal finance. The latest volume in Greenwood's new Student Guides to Business and Economics series, Stocks and Bonds gives readers an in-depth yet reader-friendly look at these integral components of the U.S. and global economy. It explores the different types of bonds, how stocks and stock exchanges work, and why periodic crashes and crises occur. It explains fundamental concepts such as risk versus return, interest rates, and behavioral economics, using real-world examples to illustrate key points. It also provides practical tried-and-true recommendations for investing in stocks and bonds.

Purpose: The purpose of this study was to investigate the influence of convertible bonds on liquidity growth of commercial banks in Nairobi county KenyaMethodology: This research applied descriptive research design when gathering data by closed-ended questionnaires on 39 commercial banks in Nairobi County Kenya and secondary data from commercial banks dating from 2016-2018. Overall operations managers, marketing managers and general managers were the respondents. Census technique was used. Pre-testing questionnaires was issued to branch marketing managers, operational managers and assistant managers in simple randomly selected five commercial banks located in Meru county Kenya. SPSS data analysis software was be consulted for quantitatively using the descriptive statistics such as mean, percentage and standard deviation. Tables, graphs and detailed explanations was used to present the final results of the study.Results: The study found out that there was a statistically significant positive relationship between convertible bonds and liquidity growth of commercial banks in Nairobi county Kenya. Convertible had an R value of .732 and an R square value of 0.536. This proved that convertible bonds predicted 53.6% of the changeability in the liquidity growth. The regression coefficients of convertible bonds had a β=.117, P=010 at 0.00 significance level.Unique contribution to theory, policy and practice: The discovery of presence of positive influence of convertible bonds on liquidity growth led to new knowledge contribution by the study. The study recommended that more types of customized bonds should be issued and public awareness should be raised. The study recommended that policies should be developed by government through the central bank whereby bank customers can obtain bonds more often just like the way mobile loan apps are common. This would promote more market for the bonds. Commercial banks should also indemnify various types of bonds with insurance firms so that any misfortune of events like the recent covid-19 pandemic would have minimal impact on the various types of fixed-rate bonds. The study contributed new knowledge when the relationship between corporate bonds and liquidity growth of commercial banks in Nairobi was established.

Typically, implied volatilities for defaultable instruments are not available in the financial market since quotations related to options on defaultable bonds or on credit default swaps are usually not quoted by brokers. However, an estimate of their volatilities is needed for pricing purposes. In this paper, we provide a methodology to infer market implied volatilities for defaultable bonds using equity implied volatilities and CDS spreads quoted by the market in relation to a specific issuer. The theoretical framework we propose is based on the Merton’s model under stochastic interest rates where the short rate is assumed to follow the Hull–White model. A numerical analysis is provided to illustrate the calibration process to be performed starting from financial market data. The market implied volatility calibrated according to the proposed methodology could be used to evaluate options where the underlying is a risky bond, i.e. callable bond or other types of credit-risk sensitive financial instruments.

PurposeThis paper aims to report practice-relevant anomalous investment yield behavior of two types of bonds – Type A, the mainstream bond, and Type B, which is Sukuk – both having similar cash-flow-relevant characteristics.Design/methodology/approachBond valuation theory suggests that yields to investors of similarly rated bonds ought to be same. The authors collected time-series data on A and B bonds, all being coupon-paying bonds with similar rating and similar tenor as two matched samples traded in a bond exchange. To ensure the results are extended to different bond sectors, the data set was separated into treasury bonds as risk-free and corporate bonds as risky ones. The data set was further sub-divided into short-, medium- and long-tenor bonds. As the data straddle the Global Financial Crisis period, the authors use appropriate econometric method to control the possible effect from the crisis.FindingsThe average and median yields on Type A bond are significantly different from those of Type B. The test results show significant and systematic differences: treasury bonds of Type A returns yield lower than treasury bonds of Type B; the yields of corporate mainstream bonds (A) are higher than the yields of Sukuk (B). The authors observe these findings constitute a puzzle, being anomalous to theory.Originality/valueThis paper is original in that it is documenting significant differences in pricing of equivalent bonds. This has both theory and practice implications for fixed-income security market practices. The evidence is very strong to suggest that the identical types of bonds may have missing variable that contributes to the difference. Therefore, further research to identify the missing variable is necessary.

This article examines the impact of macroeconomic announcements on corporate bond prices and investor migrations across various types of bonds over time. In addition, the authors compare the responses of investor-grade bonds and speculative corporate bonds. They find corporate bond responses to be different from those of Treasury bonds. Positive macrosurprises are followed by declining (rising) yields on corporate bonds (Treasuries), implying that investors may be migrating between Treasuries and corporate bonds very rapidly. They also identify that the sensitivity of junk bonds is more pronounced than that of investment-grade bonds. Finally, they document that the behavior of corporate bonds is very similar to that of their equity counterparts in that they exhibit greater sensitivity to negative macroshocks than to positive shocks.

The effect of quantities outstanding on the term structure of interest rates has provoked much discussion in the literature. De Leeuw (1965) tests whether the levels and the change in levels of various debt categories affect the spread between the long-term US government bond rate and the Treasury bill rate: only the changes in debt outstanding prove significant, so that in his model there are no permanent rate effects of the quantity of debt outstanding. Modigliani and Sutch (1966) also find no significant quantity effects in a reduced-form regression of the spread between the long-term US government bond rate and the bill rate on a distributed lag of short-term interest rates; and Modigliani and Shiller (1973) do not mention the possible effects of quantities: they identify the difference between long and short rates that is not explained by expectations with a risk premium and relate it to the variability of interest rates. Feldstein and Eckstein (1970) find a significant positive effect for real per capita government debt in an equation for the US long-term corporate bond rate, but the magnitude is small. Furthermore, in a more recent study emphasizing price expectations in several markets by Feldstein and Chamberlain (1973), this variable is no longer significant in explaining the rate on newly issued corporate bonds. For the United Kingdom, both Rowan and O'Brien (1970) and Buse (1975) test supply variables in equations explaining the spread between long and short rates; but in some specifications Rowan and O'Brien get the wrong sign for them, and Buse, after correction for autocorrelation, gets a t-value of only 1-67 on the proportion of long-term bonds in total British government debt. In the Canadian context, Dobson (1973) and Christofides (1975) find significant quantity effects for some maturities of Canadian government bonds, but the impact of even such a massive change in outstanding quantities as the Conversion Loan of 1958 appears to be small. All of the studies cited above have relied on reduced-form regressions rather than estimating structural models of the demand and supply for the various maturities of bonds, though some of the reduced forms are derived from explicit structural models. (A more recent exception is Friedman (1977), who estimates a structural model.) The advantages of structural models are well known, however. An over-identified structural model implies certain restrictions on the reduced form, and ordinary least squares estimation of the unrestricted reduced form will be (asymptotically) inefficient relative to three-stage least squares or full information maximum likelihood estimation of the structural model (see Dhrymes, 1973). Consequently, even though quantity variables may not be significant when an unrestricted reduced-form term structure equation is estimated, because of lower standard errors they may be significant when a structural model is estimated and its reduced form is calculated.

10 - The default risk of corporate bonds

This study develops a new test of market efficiency of bonds using data from the Yahoo Bond Screener on 15 March 2014. The test examines three types of bonds; zero coupon US Treasury Bonds, Fitch rated AAA corporate bonds and BB corporate bonds. AAA was the most efficient types of bonds, Zeros were next and BB rated bonds were the least efficient. This provides an empirical way to rate bonds which can supplement the expert judgment of analysts. It may also be used to identify bonds which are mispriced.

Bond and shares form part of the capital markets. Shares are equity capital while bonds are debt capital. So bonds are a form of debt, much as a bank loan is a form of debt. Unlike bank loans, however, bonds can be traded in a market. A bond is a debt capital market instrument issued by a borrower, who is then required to repay to the lender/investor the amount borrowed plus interest, over a specified period of time. Bonds are also known as fixed income instruments, or fixed interest instruments in the sterling markets. Usually bonds are considered to be those debt securities with terms to maturity of over one year. Debt issued with a maturity of less than one year is considered to be money market debt. There are many different types of bonds that can be issued. The most common bond is the conventional (or plain vanilla or bullet) bond. This is a bond paying regular (annual or semiannual) interest at a fixed rate over a fixed period to maturity or redemption, with the return of principal (the par or nominal value of the bond) on the maturity date. All other bonds are variations on this.KeywordsInterest RateCash FlowBond PriceInterest Rate RiskClean PriceThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

Bond ratings are becoming confusing because rating agencies have adopted inconsistent rating definitions for different kinds of securities. Standard &amp; Poor9s rating definitions illustrate the issue most vividly. S&amp;P9s rating symbols correspond to different default probabilities for 1) corporate bonds, 2) mortgage and asset backed securities, and 3) collateralized bond obligations. At Moody9s, the rating scale for U.S. municipal bonds is calibrated to different levels of expected loss than is the rating scale for all other types of bonds. Inconsistent rating definitions undermine the comparability of bonds from different sectors of the fixed income markets. Moreover, regulations that rely on private credit ratings often presume that each rating agency9s rating definitions are constant across market sectors (and also constant over time). Inconsistent rating definitions contradict that presumption and cast doubt on the effectiveness of the regulations. <b>TOPICS:</b>Asset-backed securities (ABS), information providers/credit ratings, credit risk management

The securities lending market allows institutional investors, such as insurance companies, to lend out asset holdings in exchange for cash collateral, an important but understudied source of funding. Since securities lenders are also primary investors in corporate bonds, we hypothesize that their lending preference for certain types of bonds can influence corporate financing policies. Indeed, we observe that a higher lender preference for long-term bonds stimulates firms to issue more such bonds and helps boost bond prices. The analysis exploiting a quasi-experiment supports a causal interpretation. Our results shed new light on the potential impact of securities lending.

Preface. Introduction. 1. What is a Bond and Who Issues Them? 1.1 Description of a bond. 1.2 The difference between corporate bonds and equities. 2. Types of Bonds and Other Instruments. 2.1 Fixed-rate bonds. 2.2 Floating-rate notes. 2.3 Index-linked bonds. 2.4 Hybrid bonds. 2.5 Other instrument types 3. How Do You Price and Value a Bond? 3.1 Compound interest. 3.2 Discounting and yield considerations. 3.3 Accrued interest. 3.4 How bonds are quoted. 3.5 Bond pricing. 3.6 Yields and related measures. 3.7 Floating-rate notes. 3.8 Real redemption yield. 3.9 Money market yields and discounts. 4. Bond Options and Variants. 4.1 Callable bonds. 4.2 Putable bonds. 4.3 Convertible bonds. 4.4 Dual currency bonds. 4.5 Mortgage-backed securities. 4.6 Collateralized debt obligations. 4.7 Bonds with conditional coupon changes. 4.8 Reverse floaters. 4.9 Bonds with warrant attached. 5. Yield Curves. 5.1 Yield curve shapes. 5.2 Zero-coupon or spot yield curves. 5.3 Forward or forward-forward yield curves. 5.4 Par yield curves. 5.5 Investment strategies for possible yield curves changes. 6. Repos. 6.1 Classic repos. 6.2 Sell/buy-backs. 6.3 Stock borrowing/lending. 7. Option Calculations. 7.1 Buying a call option. 7.2 Writing a call option. 7.3 Buying a put option. 7.4 Writing a put option. 7.5 Theoretical value of an option. 7.6 Combining options. 8. Credit and Other Risks and Ratings. 8.1 Credit risk. 8.2 Liquidity. 9. Swaps, Futures and Derivatives. 9.1 Swaps. 9.2 Credit risk in swaps. 9.3 Swaptions. 9.4 Futures. 9.5 Credit default swaps. 10. Portfolios and Other Considerations. 10.1 Holding period returns. 10.2 Immunization. 10.3 Portfolio measures. 10.4 Allowing for tax. 11. Indices. 11.1 Bond index classification. 11.2 Choosing indices. 11.3 Index data calculations. 11.4 Index continuity. Appendix A: Using the Interactive Website. Appendix B: Mathematical Formulae.

This paper has the purpose of testing the expectations hypothesis of the term structure for two corporate bond yields. A new test is developed based on an ARIMA data generation process of the short rate, and on the derivation of a relation between the change in the long rate and revisions of expectations of future short rates. The paper makes the point that adjustment of the change in the long rate to short rate news does not occur instantaneously but is dynamic over time. For this reason a polynomial distributed lag of the short rate news, which provides support to the expectations hypothesis, is estimated. This is quite remarkable because the liquidity, term, and default risk premiums are left out of the analysis. JEL Code Classifications: E43, G12, C22.

The enterprise bond is basically the corporate bond. However, it has a different characteristic in that it mainly supports government financing for Chinese economic development. We analyse credit spread determinants of enterprise bond and corporate bond by using WIND system data from 2013 to 2018, which is the period when the volume of both bond types grew very rapidly. We use random effect panel regression. We find that factors related with default probability such as credit score and profitability have the same effect with theoretical expectation. However, there is a different or opposite effect between both bond types for GDP growth rate, inflation and debt ratio. Since the purpose of enterprise bond issues is supporting financing for economic development such as infrastructure, the enterprise bond spread has a negative effect for inflation and debt ratio, and a positive effect for GDP growth. We find there is no significant evidence for government premium proxied by the major shareholder dummy variable, which implies that the market poses its confidence at the profitability of the private sector rather than the government premium in the Chinese bond market.