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Andreas42

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tT
发表于 2011-7-11 19:30 | 只看该作者

Qbank Q:Interest rate affects on callable and putable bonds

decrease, believes, attractive, increase
Question and then my comment below:




Wall believes he understands the relationship between interest rates and straight bonds but is unclear how callable bonds change as interest rates increase. How do prices of callable bonds react to an increase in interest rates? The price:
A) decreases.
B) may increase or decrease.
C) increases.

Your answer: C was incorrect. The correct answer was A) decreases.

Since the bond has a fixed coupon it becomes relatively less attractive to investors when interest rates increase. Its cash flows are now discounted at a higher discount rate which reduces the value of the bond. (Study Session 14, LOS 54.e, f)




I am not getting this. When rates go down there is a higher chance that issuers will call the bond, so I would think that low rates make callable bonds unattractive. Therefore, it seems that an INCREASE in interest rates would make callable bonds more attractive/less risky for the investor. Why then does the Q say that the price of callable bonds will decrease?
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Houjichasan

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2#
发表于 2011-7-11 19:30 | 只看该作者
tenten Wrote:
-------------------------------------------------------
> Question and then my comment below:
>
>
>
>
> Wall believes he understands the relationship
> between interest rates and straight bonds but is
> unclear how callable bonds change as interest
> rates increase. How do prices of callable bonds
> react to an increase in interest rates? The
> price:
> A) decreases.
> B) may increase or decrease.
> C) increases.
>
> Your answer: C was incorrect. The correct answer
> was A) decreases.
>
> Since the bond has a fixed coupon it becomes
> relatively less attractive to investors when
> interest rates increase. Its cash flows are now
> discounted at a higher discount rate which reduces
> the value of the bond. (Study Session 14, LOS
> 54.e, f)
>
>
>
>
> I am not getting this. When rates go down there
> is a higher chance that issuers will call the
> bond, so I would think that low rates make
> callable bonds unattractive. Therefore, it seems
> that an INCREASE in interest rates would make
> callable bonds more attractive/less risky for the
> investor. Why then does the Q say that the price
> of callable bonds will decrease?

Just because they are more attractive doesn't mean it will overpower the effect of interest rates on the bond price.

NO EXCUSES

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b_sea93

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3#
发表于 2011-7-11 19:30 | 只看该作者
non-callable bond = callable bond + option cost.

Volatility always increases the option cost. Hence, all things being equal the callable bond price should decrease.

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Analyze_This

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4#
发表于 2011-7-11 19:30 | 只看该作者
no...

callable bond = non-callable bond - option cost

reason: Call is at the option of the issuer. he must make it worth investor's while to invest in a callable bond.

putable bond = non-putable bond+option cost.
put is at the option of the investor.

Please correct me if I am wrong here.

CP



Edited 1 time(s). Last edit at Sunday, May 2, 2010 at 11:37AM by cpk123.

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neil1234

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5#
发表于 2011-7-11 19:30 | 只看该作者
cpk123 Wrote:
-------------------------------------------------------
> no...
>
> callable bond = non-callable bond - option cost
>
> reason: Call is at the option of the issuer. he
> must make it worth investor's while to invest in a
> callable bond.
>
> putable bond = non-putable bond+option cost.
> put is at the option of the investor.
>
> Please correct me if I am wrong here.

Oh yes you and wisprud were correct. My mistake.

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