The purpose of this study is to analyze the price of publicly offered convertible bonds issued at year of 1997, 1999 and traded at year of 2000 in Korea. Using the Roll, Geske, and Whaley formula for the value of an American option on a stock paying dividend and Binomial Tree model developed by Cox, Ross, and Rubinstein, we evaluate the call warrant embedded on convertible bonds and estimate the theoretical price of convertible bonds. Then we compare theoretical prices with issuing prices and market prices. After statistical tests, we discover some facts on convertible bonds in Korea.
First, it is tolerate to use above mentioned methods interchangeably to value convertible bonds under 0.05 and 0.01 level of significance.
Second, the issuing price of CBs is relatively low compared to the theoretical price and convertible bonds are traded more cheaply than the theoretical price. Especially in case of deeply out of the money situation of the secondary convertible bond market, there are some opportunities for risk-free profit because there are some cases that the market price of convertible bonds is below the investment value which is the investment floor value of convertible bonds.
Third, the degree of deviation from the theoretical price in 1999 is increased compared to that in 1997. The difference between 1997 and 1999 is considerable under 0.05 level of significance.
Fourth, it is rare for the convertible bond to be more profitable than the straight bond in spite of relatively low issuing price compared to the theoretical price. The ratios that convertible bonds are more profitable than the straight bond in 1999 and 1997 are 34% and 26.8% respectively even though the dilution effect is not taken into account. Eventually, issuing convertible bonds is more lucrative to issuers than to investors. This is a testimony that the ‘Windows of opportunity Hypothesis’ or ‘Winner’s curse Hypothesis’ could be applicable to explain such situations.
