Options in Structured Notes: Fix the Price or Fix the Spread?

Abstract

We derive consistent contingent-claims models for valuing implicit options embedded in structured notes, and use them to compare the cost of fixing the spread with that of fixing the price in bond tender offers. We analyze 289 bond tender offers and find that the cost difference is economically significant in a substantial majority of cases. The cost difference and choice of method depend especially on whether the offer is for investment-grade or high-yield bonds. Other significant determinants of the choice of method include the percentage of issue sought, the inclusion of a consent solicitation, and a change-of-control.

Keywords: Embedded options, Bond tender offers, Investment-grade, High-yield, transactions costs

JEL Classification: G13, G32