Callable Bonds around, holding, cheaper, always, because

krause2

Trying to wrap my mind around callable bonds. Where am I wrong?

1.) If I'm holding a callable bond, I'm short a call option so the value of the bond = Value of Non-Callable - Value of Call option. So a callable bond will always be cheaper than a non-callable.

2) As rates fall a n-c will outperform a c because of the embedded call option.

3) As rates rise -:

1. From below coupon up the c expresses convexity and will outperform the n-c.
2. From above coupon to higher the call option is o-f-t-m and both bond behave like n-c.

Grade me!

wake2000

JSShekawat Wrote:
-------------------------------------------------------
> Trying to wrap my mind around callable bonds.
> Where am I wrong?
>
> 1.) If I'm holding a callable bond, I'm short a
> call option so the value of the bond = Value of
> Non-Callable - Value of Call option. So a callable
> bond will always be cheaper than a non-callable.
>
> 2) As rates fall a n-c will outperform a c because
> of the embedded call option.
>
> 3) As rates rise -:
>
> 1. From below coupon up the c expresses convexity
> and will outperform the n-c.
> 2. From above coupon to higher the call option is
> o-f-t-m and both bond behave like n-c.
>
> Grade me!

Wow talk about overthinking a simple concept.

dyga

this is incorrect: "1. From below coupon up the c expresses convexity and will outperform the n-c. "

while the c will outperform, it still has negative convexity.