Convertible Bonds Convertible Bond Pricing Model • A popular method for pricing convertible bonds is the component model – The convertible bond is divided into a straight bond component and a call option on the conversion price, with strike price equal to the value of the straight bond component – The fair value of the two components can be calculated with standard formulas, such as the famous Black-Scholes valuation formula.
• This pricing approach, however, has several drawbacks – First, separating the convertible into a bond component and an option component relies on restrictive assumptions, such as the absence of embedded options (callability and putability, for instance, are convertible bond features that cannot be considered in the above separation) – Second, convertible bonds contain an option component with a stochastic strike price equal to the bond price