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This paper explores the effect of project interrelationships on investment decisions and project values in a real options framework. We examine in detail the mutually exclusive case where a firm may invest in the development stage of two projects and then may select only a single project to implement. The firm can develop the projects in parallel or in sequence. The choice of development policy depends on the relative values of the embedded options for each strategy. Sequential development is shown to be superior to parallel development when projects have highly correlated values, and when they require a large commitment of capital for development, are short term in nature, and have relatively low volatility. We also show that the optimal ordering of sequential projects does not always begin with the most profitable project.

This study examines the wealth effects of convertible bond call announcements on stockholders, straight bondholders, and called and non-called convertible debtholders. We document that forced conversions are associated with a significant loss in firm value. The results suggest that convertible call announcements can trigger both negative signal and wealth transfer effects. We show that at least part of the negative effect on stock prices results from wealth transfer to straight bondholders. Our analysis also lends empirical validity to the common contention that called convertible bondholders suffer wealth expropriation due to the elimination of the premium. The wealth effect on non-called convertible debtholders is insignificant. Cross-sectional analysis reveals that the negative signal effect is important in explaining bond, stock, and firm excess returns. Finally, we present evidence that refutes the notion that bonds are called to relieve the firm from restrictive debt covenants.

This paper provides a closed-form, preference-free means of valuing a European call option written on a default-free pure discount bond. Investors may not agree upon a theory of the term structure, but they will necessarily agree on equilibrium option values. Further, these equilibrium option values may be obtained without recourse to numerical approximation.Default-free pure discount bond prices were posited to follow a non-standardized transformed Brownian bridge process. This specification implicitly incorporates the terminal constraint that the price of a default-free pure discount bond equal its face value at maturity.Contingent claim valuation necessarily involves consideration of terminal constraints on the value of financial securities. The Brownian bridge specification permits an appropriate means of incorporating a number of such constraints. Therefore, while this paper has considered only the application of the Brownian bridge process to the valuation of debt options, the introduction of this process may provide for many further financial applications.

Professor Jennings, in his recent article [2], developed a model to esti? mate convertible bond premiums. The model incorporates the capital asset pricing model to evaluate convertible bonds. The purpose of this comment is not to criticize the general development of the model but to point out flaws in its implementation which influence Jennings' empirical results. Jennings states that "results from the model tend to underestimate 'small' premiums and overestimate large premiums." He concludes that the bias could result from various sources such as (1) misspecification of the model, (2) sys? tematic bias in the data, (3) inefficiencies in the convertible debt market, (4) lack of simultaneous prices. There are, however, other sources of error included which bias the re? sults when the model is empirically applied. They are: (1) the discount rate assumptions, (2) dropping the floor value when the conversion value exceeds the call value, (3) calculation of the annual standard deviation, (4) calculation of transaction costs and income differences. These four sources of error

A convertible bond is a hybrid financial instrument that incorporates features of a bond (fixed income security) and an equity claim (usually common stock). In most instances the convertible can be exchanged, at the holder's option, for the common shares of the corporation issuing the convertible. The conversion value, or stock value, is the market value of the common shares for which the convertible can be exchanged. The bond value or floor price is the market value of an equivalent bond that does not include a conversion feature. The market price of a convertible will be the conversion value or the bond value, whichever is higher, plus a premium. The purpose of this paper is to develop and test a model which estimates the premium. The premium estimated is defined as the difference between the market price of the convertible and the bond value or conversion value, whichever is larger. No consideration will be given to convertible preferreds.