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Valuing Bonds with Embedded Average Price Options
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by Stephen A. Easton
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Abstract
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Average price options are based on the average (either arithmetic
or geometric) price of the underlying asset during an option's
life. Recently, Australia's largest private bank, the National
Australia Bank, and the regional Metway Bank, have issued bonds
that contain embedded arithmetic average share index options. The
purpose of this paper is to value these options using Monte Carlo
simulation, and then to value the bonds themselves. Using a wide
range of estimates of the parameters that determine the values of
these bonds, it would appear that the fixed-term deposits offered
by these same banks represent more profitable investments.
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Keywords
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AVERAGE PRICE OPTIONS; BONDS; MONTE CARLO SIMULATION.
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Contact Details
Stephen A. Easton
Associate Professor
Department of Accounting and Finance
Monash University
Clayton
Victoria, 3168
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The author would like to thank Rob Brown, Robert Faff, Alan
Farley, Paul Kofman, Paul Lalor, Patricia McBride, Keith McLaren,
Ian O'Connor, Graham Peirson, Alan Ramsay, two anonymous referees
and participants at Monash University, the Australian National
University and the Eighth Annual Australasian Finance and Banking
Conference for helpful comments.
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