Does Default Risk in Coupons Affect the Valuation of Corporate Bonds?: A contingent claims model

by Joon Kim of the Korean Advanced Institute of Science and Technology,
Krishna Ramaswamy of the University of Pennsylvania, and
Suresh Sundaresan of the Columbia University

Autumn 1993

Abstract: The early work of Black and Scholes, and Merton, made the connection between conventional options and corporate liabilities. The standard textbooks now employ option-pricing arguments in discussing the valuation of stocks, bonds, convertible bonds and warrants; this discussion extends to the various features (such as call and sinking-fund features) that now are appended to these issues. The technique is to recognize that the value of a particular security derives from, or is contingent on, the value of the firm and other economic variables (such as the yield curve for government securities), and then apply the same valuation procedure that one would use to value a call option on some underlying common stock.

Published in: Financial Management, Vol. 22, No. 3, (Autumn 1993), pp. 117-131.

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