Traditionally structured bonds have been priced by viewing the bond-like and option-like components as being distinct. So the elements of this payment stream received at the same time are being discounted at different rates. The inconsistency is due to the interest rate which is assumed to be stochastic in pricing the bond-like components , but constant in pricing the option-like components.
In this thesis, a new approach is used where the bond-like and option-like cash flows would be discounted at the same stochastic interest rate, which is assume to obey the 1 factor Cox-Ingersoll-Ross model. Using the new approach, the correlation between the interest rate and the underlying stock return is explicitly modeled.
Pricing the ELN and analyzing the sensitivity of ELN, MonteCarlo simulation is utilized and in the simulation for pricing and sensitivity analysis, the correlation between the process of stock index and interest is considered by using Cholesky Factorization. The parameters are estimated through the Mean Square Error estimation method.
Comparing the prices calculated in traditional way, the prices in a new approach are smaller and the changes of ELN value are about 1 or 5 won per 10,000 won. The figures of sensitivity could be used for dynamic hedge of ELN.
