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A Valuation Model for Callable Foreign Bonds

This paper models the value of callable foreign bonds, using stochastic calculus, by assuming that the exchange rate follows a geometric Brownian motion process and the arrival time of an early redemption of the bond by the issuer conforms to a negative exponential distribution. The solution to the stochastic model shows that there is a relationship between the call premium and the expected time to the call which is consistent with traditional Black-Scholes pricing formulae. The magnitude of the call premium can be viewed as a signal to the market on a Government treasury's or company's expectations about the future level of interest rates and possible refinancing strategies.