Pricing of Firm Bond with Extendable Maturity by Reduced Form Approach

Abstract:

The firm bond with extendable maturity endows the firm with the right to extend the maturity of the bond according as the level of market interest rate,by which the firm can evade the adverse movement of interest rate.For this right,the firm should compensate the investors of the firm bond.Besides the risk of interest rate,the investors will bear the credit risk in the extended period.We deal with the credit risk by reduced form approach.Under the assumption of stochastic interest rate,we obtain the pricing formula for firm bond with extendable maturity by PDE approach and compare its return rate with that of ordinary firm bond.