Convertible Bonds and Hybrid Securities › Key Parameters
Michael BrenndoerferNovember 20, 20251 min read
Quantitative FinanceAll chapters Part 4 of 15Swaps and Credit Derivatives
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The key parameters for the convertible bond valuation model are:
- Par Value: The face value of the bond, typically $1,000 paid at maturity. This is the numerator in calculating the conversion price.
- Conversion Ratio: Number of shares received per bond. Determines the conversion price and establishes the fundamental link between the bond and equity.
- S: Current stock price. Higher stock prices increase the value of the embedded option and the conversion value.
- r: Risk-free rate. Used to discount cash flows and value the option component.
- Credit Spread: The yield premium over the risk-free rate reflecting the issuer's default risk. Higher spreads reduce the straight bond value.
- σ: Volatility of the underlying stock. Higher volatility increases the value of the conversion option because it raises the probability of large upside moves.
- T: Time to maturity. Affects both the present value of bond payments and the option's time value, with longer maturities generally increasing option value.