Corporate debt securities and embedded options valuation using binomial model

Abstract

This article comprises an application of binomial model to evaluate corporate debt securities and its components. The main objective of this research is verify the applicability of the model to debt securities issued by Brazilian companies. The mean test which compares present value of debt securities obtained by the binomial model and the respective market value confirms the validity of the model. There are three components presented in debt securities presented in the sample: call option, conversion option and subordination. Call option decreases the debt security present value, on average, in 9,50% of nominal value and subordinated debt have its present value decreased in 8,82% of the nominal value, on average. Finally, convertible bonds (3 securities in the sample) have its present value increased in 4,11% of its nominal value, on average.