Perpetual Convertible Bonds

Abstract

A firm issues a convertible bond. At each subsequent time, the bondholder must decide whether to continue to hold the bond, thereby collecting coupons, or to convert it to stock. The firm may at any time call the bond. Because calls and conversions often occur far from maturity, it is not unreasonable to model this situation with a perpetual convertible bond, i.e., a convertible coupon-paying bond without maturity. This model admits a relatively simple solution, under which the value of the perpetual convertible bond, as a function of the value of the underlying firm, is determined by a nonlinear ordinary differential equation.

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