Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/247946 
Year of Publication: 
2018
Citation: 
[Journal:] Verslas: Teorija ir praktika / Business: Theory and Practice [ISSN:] 1822-4202 [Volume:] 19 [Publisher:] Vilnius Gediminas Technical University [Place:] Vilnius [Year:] 2018 [Pages:] 261-270
Publisher: 
Vilnius Gediminas Technical University, Vilnius
Abstract: 
In this financial engineering research, we study the behaviour of an option premium of a call/put option which is embedded in a typical fixed coupon bond with finite maturity. The contribution of the research is the conclusion about the dynamics of premium changes; represented by direction and sensitivity; with respect to the changes in credit rating and also risk-free interest rate development. The aim of the research is also to clearly demonstrate this theoretically complicated topic to the financial practitioners using a practical example. We are about to consider a 3-dimensional process where the dimensions are: time, rating development process and risk-free interest rate development. We use Standard & Poor's rating transition matrix to create rating tree and Hull-White model for modelling of risk-free interest rate development. We add embedded call/put option to the bond structure and assume the call/put option to be exercised in case of interest rates decline/rise or rating worsening/improvement. For valuation, we use the risk-neutral concept. Using a numerical solution on the 3-dimensional tree (implemented in MATLAB), we avoid problems that appear while analytical solving of partial differential equations.
Subjects: 
embedded call/put option
credit rating transition
more dimensional tree
Standard & Poor's rating
bedded option premium
rating development process
JEL: 
G1
G10
G12
G14
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by Logo
Document Type: 
Article

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