The pricing of credit-sensitive bonds, that is, bonds which have a significant probability of default, is an issue of increasing academic and practical importance. The recent practice in financial markets has been to issue high yield corporate bonds that are a hybrid of equity and risk-free debt. Also, to an extent, most corporate bonds are credit-sensitive instruments, simply because of the limited liability of the issuing enterprise. In this paper, we suggest and implement a model for the pricing of options on credit-sensitive bonds. For example, the model can be used to price call provisions on bonds, options to issue bonds, and yield-spread options. From a modelling.
