Behaviour of bond’s embedded option with regard to credit rating
In this financial engineering research, we study the behaviour of an option premium of a call/put option which is embedded in a typical fixed coupon bond with finite maturity. The contribution of the research is the conclusion about the dynamics of premium changes; represented by direction and sensi...
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| Format: | Article |
| Language: | English |
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Vilnius Gediminas Technical University
2018-11-01
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| Series: | Business: Theory and Practice |
| Subjects: | |
| Online Access: | https://journals.vgtu.lt/index.php/BTP/article/view/8140 |
| _version_ | 1797331233335672832 |
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| author | Bohumil Stádník |
| author_facet | Bohumil Stádník |
| author_sort | Bohumil Stádník |
| collection | DOAJ |
| description | In this financial engineering research, we study the behaviour of an option premium of a call/put option which is embedded in a typical fixed coupon bond with finite maturity. The contribution of the research is the conclusion about the dynamics of premium changes; represented by direction and sensitivity; with respect to the changes in credit rating and also risk-free interest rate development. The aim of the research is also to clearly demonstrate this theoretically complicated topic to the financial practitioners using a practical example. We are about to consider a 3-dimensional process where the dimensions are: time, rating development process and risk-free interest rate development. We use Standard & Poor’s rating transition matrix to create rating tree and Hull-White model for modelling of risk-free interest rate development. We add embedded call/put option to the bond structure and assume the call/put option to be exercised in case of interest rates decline/rise or rating worsening/improvement. For valuation, we use the risk-neutral concept. Using a numerical solution on the 3-dimensional tree (implemented in MATLAB), we avoid problems that appear while analytical solving of partial differential equations. |
| first_indexed | 2024-03-08T07:32:23Z |
| format | Article |
| id | doaj.art-b91885aff79a4736bc7c19727262d478 |
| institution | Directory Open Access Journal |
| issn | 1648-0627 1822-4202 |
| language | English |
| last_indexed | 2024-03-08T07:32:23Z |
| publishDate | 2018-11-01 |
| publisher | Vilnius Gediminas Technical University |
| record_format | Article |
| series | Business: Theory and Practice |
| spelling | doaj.art-b91885aff79a4736bc7c19727262d4782024-02-02T20:17:03ZengVilnius Gediminas Technical UniversityBusiness: Theory and Practice1648-06271822-42022018-11-011910.3846/btp.2018.2627451Behaviour of bond’s embedded option with regard to credit ratingBohumil Stádník0Department of Banking and Insurance, Faculty of Finance, University of Economics in Prague, W. Churchill sq.4, Prague, Czech RepublicIn this financial engineering research, we study the behaviour of an option premium of a call/put option which is embedded in a typical fixed coupon bond with finite maturity. The contribution of the research is the conclusion about the dynamics of premium changes; represented by direction and sensitivity; with respect to the changes in credit rating and also risk-free interest rate development. The aim of the research is also to clearly demonstrate this theoretically complicated topic to the financial practitioners using a practical example. We are about to consider a 3-dimensional process where the dimensions are: time, rating development process and risk-free interest rate development. We use Standard & Poor’s rating transition matrix to create rating tree and Hull-White model for modelling of risk-free interest rate development. We add embedded call/put option to the bond structure and assume the call/put option to be exercised in case of interest rates decline/rise or rating worsening/improvement. For valuation, we use the risk-neutral concept. Using a numerical solution on the 3-dimensional tree (implemented in MATLAB), we avoid problems that appear while analytical solving of partial differential equations.https://journals.vgtu.lt/index.php/BTP/article/view/8140embedded call/put optioncredit rating transitionmore dimensional treeStandard & Poor’s ratingbedded option premiumrating development process |
| spellingShingle | Bohumil Stádník Behaviour of bond’s embedded option with regard to credit rating Business: Theory and Practice embedded call/put option credit rating transition more dimensional tree Standard & Poor’s rating bedded option premium rating development process |
| title | Behaviour of bond’s embedded option with regard to credit rating |
| title_full | Behaviour of bond’s embedded option with regard to credit rating |
| title_fullStr | Behaviour of bond’s embedded option with regard to credit rating |
| title_full_unstemmed | Behaviour of bond’s embedded option with regard to credit rating |
| title_short | Behaviour of bond’s embedded option with regard to credit rating |
| title_sort | behaviour of bond s embedded option with regard to credit rating |
| topic | embedded call/put option credit rating transition more dimensional tree Standard & Poor’s rating bedded option premium rating development process |
| url | https://journals.vgtu.lt/index.php/BTP/article/view/8140 |
| work_keys_str_mv | AT bohumilstadnik behaviourofbondsembeddedoptionwithregardtocreditrating |