CHAPTER 13
The Valuation of Bonds with Embedded Options and Debt Options—The Binomial Interest Rate Tree
Introduction
Many bonds have a call feature giving the issuer the right to buy back the bond from the bondholder. In addition to callable bonds, there are also putable bonds, giving the bondholder the right to sell the bond back to the issuer, sinking fund bonds in which the issuer has the right to call the bond or buy it back in the market, mortgage- and asset-backed securities with prepayment options on the underlying collateral, and convertible bonds that give the bondholder the right to convert the bond into specified number of shares of stock.
The inclusion of option features in a bond contract makes the evaluation of such bonds more ...
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