Bankruptcy Prediction of Corporate Coupon Bond with Modified First Passage Time Approach

Abstract

Most corporations considering debt liabilities issue risky coupon bonds for a finite maturity which tipically matches the expected life of the assets being financed. For valuing these coupon bond, we can consider the common stock and and coupon bonds as a compound option. The other problem is bond indenture provisions often include safety covenants that give bond investors the right to reorganize a firm if its value falls below a given barrier. This paper will shown how to value bonds with coupon based on the first passage time approach. We will construct a formula for probability of default at the maturity date by computing the historical low of firm values. Using Indonesian corporate coupon bond data, we will predict the bankruptcy of this firm. Keywords: safety covenants, default barrier, probability of default, compound option