Call options inclusion

In this chapter we present a discussion on convertible bonds, which have become popular hybrid financial instruments. Convertible bonds are financial instmments that give the bondholders the right, without imposing an obligation, to convert the bond into underlying security, usually common stocks, under conditions illustrate in the indenture at the time of issue. The hybrid characteristic defines the traditional valuation approach as the sum of two components the option-free bond and an embedded option (call option). The option element makes the valuation not easy, above all in pricing term sheets with specific contract clauses as the inclusion of soft calls, put options and reset features. The chapter shows practical examples of valuation in which financial advisors and investment banks adopts in different contexts. 

Step-up callable notes are a particular type of structured fixed income products. These bonds offer a coupon payment that increase during the bond s life. Moreover, they include a call option, that as we discussed earlier, the issuer has the right to redeem the bond early. The question, whether a callable step-up note will be called or not always depends on the evolution of interests rates. Therefore, the inclusion of these two characteristics makes the bond attractive to investors with higher performance than a conventional bond. The added variable coupon element acts for an investor as cushion compared to a conventional callable bond. In fact, the increasing coupon payment increases the value of a callable bond. However, if interest rates go down and coupon payments increase, the incentive of the issuer to redeem the bond early is greater than a simple callable. 

As shown in Figure 11.15, the added step-up feature increases the value from 106.13 to 108.5. However, the inclusion of this feature affects also the values of the embedded call option and callable bond. In practice, increasing the value of the conventional bond at each node increases the value of the embedded option. The call option is now 4.5. As a conventional callable bond, the value of a call option is then subtracted to the one of an option-free bond. Figure 11.16 shows that the value of a step-up callable note is 104. 

An option input of 1 can be used to alter the F maPix called the core matrix. Elements can be entered or altered off the diagonal or, for inclusion of heteroatoms, by designating on-diagonal elements. The prompts and response formats for the E maP ix are similar to those of the G maPix. This opPon is similar to heteroatom inclusion in HMO. We shall use option 1 in Part C below. After all options have been entered, the final option is 0, which causes the calculation to be carried out. In... 

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