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Siddimaula

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tT
发表于 2011-10-13 11:19 | 只看该作者

Convertible perpetuity valuation

valuation, different, following
How would one value the following security:
1. it is a convertible perpetuity
2. the issuer has (at any time) the option to withhold the payment of interest
3. the issuer and the holder have at any time the option to convert the security into common stock.
All I know is that one need to value three different securities: a perpetuity, a call and a put, but given the indefinite time frame and the issuer option to withhold interest payments I have no idea how to proceed further. Why?For one thing the BS formula tells me that both put and call with extreme time to maturity (I put in 5000 years) have a 0 value when risk free rate is 4% and dividend yield is 2%.
Any thoughs?
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anothercfainnyc

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2#
发表于 2011-10-13 11:24 | 只看该作者
first of all, perpetual puts and calls are of the american type (obviously, otherwise you have to wait for perpetuity to be over before you can exercise which can take a while). you can't value them with BS at all, which is for european-type of exercise. for a dividend-paying stock, an optimal exercise boundary exist and there is a non-trivial formula (due to Robert Merton) for the value of a perpetual puts/calls which is very different from Black-Scholes. look it up in a textbook.

however, what you are describing doesn't fully make sense. if both the issuer and the holder have the right to force conversion at any time, at the same conversion rate, then either one or the other will do it today. then the value of your security is trivially equal to the stock price times the number of conversion shares.

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LBriscoe

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3#
发表于 2011-10-13 11:46 | 只看该作者
I trade and value convertibles, convertible preferreds, mandatories, etc. Most registered perpetual convertibles are callable by the company (say 5-7 years from issue) at par, are noncumulative, and a strike with a 15-30% premium.

So to value this, main assumptions are volatility, underlying dividend (the preferred may be protected), credit assumption for the preferred (typical rule of thumb is +200 bp from where debt trades), and underlying borrow cost (today (given) but future borrow cost may rise).

In some cases, an IB will detach the warrants associated with the preferred (called a unit when combined) and trade the unit and straight preferred separately.

If this is a registered security post the ticker/cusip and I will see if I can value, otherwise you will need to post some specifics for me to help get a valuation.

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Andreas42

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4#
发表于 2011-10-13 11:52 | 只看该作者
The bank that I work for is considering to issue such a security. The problem is how to set both strike prices (for put and call) as well the coupon rate. And to make things even sexier, the bank doesn't have listed shares so market price of common stock is a mystery as well.

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