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The Handbook of Convertible Bonds: Pricing, Strategies and Risk Management


Having both equity and debt like features, convertible bonds are highly complex, challenging new market entrants to incorporate credit and equity together into their existing pricing tools.

The Handbook of Convertible Bonds is a comprehensive guide to the pricing and risk management of this highly profitable asset class in a post credit crunch setting.

Part I introduces the convertibles market, covering the impact that the 2008 credit crunch has had on the markets. It shows how to build up a convertible bond and introduces the reader to the traditional convertible vocabulary of yield to put, premium, conversion ratio, delta, gamma, vega and parity. The market of stock borrowing and lending is also covered in detail. Using an intuitive approach based on the Jensen inequality, the authors also show the advantages of using a hybrid to add value. The authors then go on to give the advantages of using a hybrid to add value. The authors then go on to give a complete explanation of the different features that can be embedded in convertible bonds. Part II shows readers how to price convertibles, covering the different parameters used in valuation models: credit spreads, volatility, interest rates ad borrow fees and maturity. Part III concludes the book by covering the all important risk management part of the process in detail.

This is a highly piratical book, all products priced are real world examples and numerical examples are not limited to hypothetical convertibles. It is a must read for anyone wanting to safely get into this market.

Jan De Spiegeleer (Geneva, Switzerland) is Head of Risk Management at Jabre Capital Partners, a Geneva-based hedge fund. He developed an extensive knowledge of derivatives pricing, hedging and trading while working for KBC Financial Products in London, where he was Managing Director of the equity derivatives desk. Prior to his financial career, Jan worked for ten years as an officer in the Belgian Army, and served in Iraq.

Wim Schoutens (Leuven, Belgium) is a research professor in financial engineering in the Department of Mathematics at the Catholic University of Leuven, Belgium. He has extensive practical experience of model implementation and is well known for his consulting work to the banking industry and other institutions. Wim is the author of Lévy Processes in Finance and Lévy Processes in Credit Risk, and co-editor of Exotic Option Pricing and Advanced Lévy Models all published by John Wiley and Sons. He is Managing Editor of the International Journal of Theoretical and Applied Finance and Associate Editor of Mathematical Finance, Quantitative Finance and Review of Derivatives Research.

Reading this Book.




1 Terminology.

1.1 The Payoff.

1.2 Advantages of Convertibles.

1.3 Basic Terminology.

1.4 Advanced Terminology.

1.5 Legal Terminology.

1.6 Analytics and Hedge Ratios.

2 Convertible Bond Anatomy.

2.1 Payoff to the Investor.

2.2 Payoff Graph.

2.3 Boundary Conditions.

2.4 Effect of the Call Protection.

2.5 Announcement Effect.

3 Convertible and Hybrid Structures.

3.1 Preferred Shares.

3.2 Convertible Bond Option.

3.3 Reverse Convertible.

3.4 Perpetuals.

3.5 Cross-Currency.

3.6 Mandatory.

3.7 Cashout Option.

3.8 Exchangeable.

3.9 Dividend Entitlement.

4 Convertible Bonds Market.

4.1 The Convertible Universe.

4.2 The Prospectus.

4.3 The Investors.

4.4 Market Participants.

4.5 New Issuance.


5 The Road to Convexity.

5.1 Break-Even Analysis.

5.2 Discounted Yield Advantage.

5.3 Convexity.

5.4 Jensen's Inequality.

5.5 Time Decay.

5.6 Double-Signed Gamma.

5.7 Colour.

5.8 First Steps Using Convexity.

6 Basic Binomial Trees.

6.1 Models.

6.2 The Basic Ingredients.

6.3 A Primer in Stochastic Calculus.

6.4 Elementary Credit Model.

6.5 Binomial Equity Models.

6.6 Pricing Convertibles Using Binomial Trees.

6.7 Credit Spread Modelling in Binomial Trees: A Practitioner's Approach.

6.8 Conclusions.

7 Multinomial Models.

7.1 Convergence of the Binomial Model.

7.2 Moments.

7.3 Multinomial Models.

7.4 Trinomial Model.

7.5 Heptanomial Model.

7.6 Further Optimization.

7.7 Other Refinements.

7.8 Resets in Multinomial Models.

8 Ascots.

8.1 Risk Components of a Convertible.

8.2 Asset Swaps.

8.3 Ascots.

8.4 Advantages for the Credit Buyer.

8.5 Advantages for the Ascot Buyer.

8.6 Pricing of Ascots.

8.7 Ascot Greeks.

8.8 CB Warrants.


9 Measuring the Risk.

9.1 Portfolio Risk.

9.2 A Portfolio in Trouble.

9.3 Risk Categories.

9.4 Coherent Risk Measures.

9.5 Option Greeks.

9.6 Fixed Income Measures.

9.7 Cross Greeks.

9.8 Speed and Colour.

9.9 VaR and Beyond.

9.10 Back Testing.

9.11 Stress Testing.

10 Dynamic Hedging.

10.1 Hedge Instruments.

10.2 Delta Hedging.

10.3 Volatility.

10.4 Gamma Trading.

10.5 The Variance Swap.

11 Monte Carlo Techniques for Convertibles.

11.1 Adding More Realism.

11.2 Monte Carlo Method.

11.3 American Monte Carlo.