Research On Convertible Bonds Valuation And The Investment Strategies

Convertible bonds has appeared in China security market a few years ago, with drastic progress in recent years, which has already ranked among the main financial instruments for listing companies and investment varieties at the second-market. For the pricing theory of convertible bonds has neither been fully studied, nor sensed by market-participants, there arise a series of problems such as the relatively low price of convertible bonds at market, and mismatch of revenue and risk, etc. Thus, the appropriate pricing of convertible bonds bear favorably on investors and issuers, as well as the healthy development of the convertible bonds market.This paper stars with some basic concepts and features of convertible bonds, along with description of the recent development of domestic market. Tracing back to the theories at home and abroad concerned convertible bonds, the author gives an in-depth study on some theoretical articles of international fame on convertible bonds and holds that predecessors' great achievements of study will offer great insights to our pricing of convertible bonds, which include Ingersoll's single-factor model (1977) , Brennan and Schwartz's two-factor model(1977), and newly established two-factor model of Ho and Pfeffer (1996) , with the latter two of great practical value. Combined with situations in China in this paper, convertible bond value is regarded as the derivative of underlying stock price. The author begins with the domestic design of terms for convertible bonds, and then prescriptively analyzes the stock nature and the bond nature of convertible bonds, as well as principles of pricing of convertible bonds. While in positive study, two-factor pricing model is adopted: Bond price=Investment value+Warrant -Call option value. On the basis of Black-Scholes model for the calculations of the option value, the spots on the revenue rate curve of similar corporate bonds are referred as discount yield rate, and weekly closed price of Wanke convertible bonds are taken as samples for positive study. It has been found that the theoretical value of convertible bonds is higher than their market value before conversion date, which constitutes underpricing; during the period of call notice , market price of convertible bonds is closer to parity value and higher than theoretical price, and thus arise dramatic errors in both periods; the theoretical price in the gap between the two periods can be basically counted as reference to market price. The reasons of the underpricing include: the low liquidity of convertible bonds, which restricts the price-founding function of the market, and the lack of short-sell, which can achieve free arbitrage if the market prices departure the equilibrium prices.This paper furthers its positive study on the value constitution of convertible bondsissued from 2002 to 2003, whose findings shows that most convertible bonds are verysensitive to the fluctuations of stock prices, and parity premium runs low, even negative, that is, parity is higher than market price of convertible bonds, capable of obvious arbitrage space.In consideration of positive results and features of domestic convertible bonds, the author presents the investment strategies of convertible bonds. Namely, positive study informs us of the existent grave errors in the pricing at domestic convertible bonds market, and thus invalidity can be used to gain risk-free arbitrage revenue, the transactions of which are, objectively, able to prompt the return of the market value to the theoretical value and the deduction of the invalidity of market, and should invite favorable evaluation.Of course, this paper is not perfect. It doesn't involve the dilution effect of the conversion from bonds to stocks, the effect on option price brought by fluctuations of interest rate, and the discrepancy between the execution of the option pricing adopting 30% increase of call terms and that of reality. Consequently, further discussion will be called for.