A Valuation Model for Callable Foreign Bonds

U of New South Wales Banking & Finance Working Paper

9 Pages Posted: 1 Oct 2001

See all articles by John Pointon

John Pointon

University of Plymouth

Vincent J. Hooper

SP Jain School of Global Management

Date Written: 2001

Abstract

This paper models the value of callable foreign bonds, using stochastic calculus, by assuming that the exchange rate follows a geometric Brownian motion process and the arrival time of an early redemption of the bond by the issuer conforms to a negative exponential distribution. The solution to the stochastic model shows that there is a relationship between the call premium and the expected time to the call which is consistent with traditional Black-Scholes pricing formulae. The magnitude of the call premium can be viewed as a signal to the market on a Government treasury's or company's expectations about the future level of interest rates and possible refinancing strategies.

Keywords: stochastic calculus, callable foreign bonds, term to maturity, Poisson distribution, negative exponential, geometric Brownian motion, call feature, refinancing strategy

JEL Classification: G15

Suggested Citation

Pointon, John and Hooper, Vincent James, A Valuation Model for Callable Foreign Bonds (2001). U of New South Wales Banking & Finance Working Paper, Available at SSRN: https://ssrn.com/abstract=285317 or http://dx.doi.org/10.2139/ssrn.285317

John Pointon

University of Plymouth ( email )

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Vincent James Hooper (Contact Author)

SP Jain School of Global Management ( email )

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