Pricing of convertible bonds using discrete and continuous time models

Abstract

A hybrid financial instrument is a financial instrument which has characteristics of both equity and debt. An example of a hybrid financial instrument is a Convertible bond. Convertible bonds offer an interest return from the debt component as well as capital gain from the equity component. The main aim of this thesis is to delve into the theory of modelling the price of convertible bonds. We look at the derivation of various pricing models in continuous time. Then, we consider discrete time approximations of the pricing models, using the binomial model and finite difference method. To conclude, we implement the models in MATLAB and see the performance of the approximations for the different pricing models for different market parameters.