Dividend Yield and Equity Discounting in the Tsiveriotis–Fernandes Model

Summary

The document frames a valuation question about the equity component of a convertible bond under the Tsiveriotis–Fernandes approach. It distinguishes the cash component, which represents coupons and principal and is discounted at a risky rate, from the equity component, which represents principal converted into shares and is treated as risk-free in the model.

The specific issue is whether a stock’s continuous dividend yield should change the equity discount rate from the risk-free rate r to r minus q during a rollback. The text offers no answer, derivation, numerical example, or comparison of model conventions, so it identifies a modeling question rather than teaching a resolved procedure. Its usefulness is limited to clarifying the decomposition and the dividend-yield question a practitioner may need to investigate.

Key ideas

• The TF approach divides convertible bond value into cash and equity components.
• The cash component is discounted using a rate that includes credit spread.
• The document asks whether continuous dividend yield changes the equity component’s discount rate.
• No resolution or supporting evidence is provided.

Tags

# What is the discount rate for equity component under the Tsiveriotis and Fernandes (1998) approach?


# What is the discount rate for equity component under the Tsiveriotis and Fernandes (1998) approach?












In the TF model, valuation of convertible bond has been decomposed into two parts:

- cash part (risky part): coupon, principal

- equity part (risk-free part): conversion of principal into shares

In the rollback process, the cash part is discounted by a risky rate (with credit spread on top of the continuous compounding risk-free rate r). However, if that stock has a non-zero continuous dividend yield q, should the equity part be discounted by r-q instead of r?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.