The Effect of Embedded Options on the Financial Performance of Convertible Bond Funds

Abstract

This study is the first to analyze the pricing of convertible bonds by examining the financial performance of open-end convertible bond funds. The findings indicate that (1) in general, convertible bonds did not outperform straight low-grade corporate bonds during the study period, January 1962 through September 1994; (2) convertible bonds are significantly more equitylike and significantly less bondlike than low-grade bonds; and (3) convertible bonds display a strong January effect. The results suggest that the equity call option embedded in convertible bonds was appropriately priced during the study period.