convertible bond - pop quiz

Which of the following factors must be included in an option-based valuation approach to price a callable convertible bond? A) Stock prices only. B) Interest rates only. C) Interest rates, stock prices and their correlation. D) Interest rates and stock prices only.

D,but I am trying to think why not C.

C for sure.

Correlation matters. C

so,whats an example of the correlation? : is it the change in the risk free rate that in turn affects the capm required return on the stock?.

i think it may be D

If interest rates go up and the stock’s correlation to interest rates is 1 I think it should matter. C

D Interest rates affect value of bond and Stock price the conversion premium. Correlation - is implicit

and i’m a D here- i think if it’s convertible you could figure it out just w/ the stock px and interest rate. could be wrong though!

It’s a tough question - I’ve seen models that include it and models that don’t. Two things: a) Converts are usually called to get them to convert, not because they want to refinance at lower rates b) Credit is not mentioned but huge.


Stock prices…check Interest rates…check correlation between stock prices and interest rates…it’s in the valuation, but not sure if it’s a factor for pricing it. I’ll say d but wouldn’t be surprised to see c.

I think, in the book it’s only Interest rates and stock prices. But the correct answer is C as per QBank. I will need to confirm this later on and see how the correlation speaked it’s way to the list and UPPED the answer from D to C. :frowning:

I would’ve put C too.