The valuation of a Euro-Convertible Bond

A Euro-Convertible Bond (ECB) is a hybrid security with the properties of both stock and bond. Further, since there are two currencies involved in this hybrid security, in addition to the conversion option, there is also a currency option embedded. We employed Least Square Monte Carlo simulation (LSM) approach developed by Longstaff and Schwartz (2001) to value ECB. The value of conversion option and currency option embedded in ECB were extracted from the differences between values of pure corporate bond, convertible bond (CB), and ECB. We also investigate the effects of exchange rate volatility, stock price volatility and correlations of state variables to the value of ECB.