The use and pricing of convertible bonds

Abstract

This paper provides an overview of the main results of the literature on pricing convertible bonds. It covers simple convertible bonds which are non-callable and can be converted only at maturity as well as more complicated callable and puttable convertible bonds under stochastic interest rates. The paper also reviews the main results in the literature on why firms issue convertible bonds. The two most often cited rationales for issuing convertible bonds - as delayed equity, and to sweeten debt - are discussed in the context of both asymmetric information and agency models of capital structure. Finally, the paper provides some thoughts on incorporating strategic issues into the pricing of convertible bonds.