Pricing resettable convertible bonds using an integral equation approach

In this paper, the fair price of an American-style resettable convertible bond (CB) under the Black–Scholes model with a particular reset clause is calculated. This is a challenging problem because an unknown optimal conversion price needs to be determined together with the bond price. There is also an additional complexity that the value of the conversion ratio will change when the underlying price touches the reset price. Because of the additional reset clause, the bond price is not always a monotonically increasing function with the underlying price, which is impossible for other types of the CBs. Of course, the problem can be dealt with using the Monte-Carlo simulation. But, a partial differential equation (PDE)/integral equation approach is far superior in terms of computational efficiency. Fortunately, after establishing the PDE system governing the bond price, we are able to present an integral equation representation by applying the incomplete Fourier transform on the PDE system.