Receiver swaption - call option on bond someone, convert, equivalent

pawn

Can someone please explain how a receiver swaption is
- equivalent to call option on bond
- how it can be used to convert non callable bond to callable bond.

I wrote that down in my notes but forgot the logic.

Analyze_This

When you buy a receiver swaption, you have paid a premium for it.

When interest rates go down, you would not want to pay the 8% on the coupon. So you exercise the swaption. Cash flows:

Pay 8% on bond
Receive 8% of fixed side of swap
Pay LIBOR (which has gone down)

NET: Pay LIBOR.

When interest rates go up, you are quite happy that you only have to pay 8%. So you do not exercise the swaption. Cash flows:
Pay 8% on bond.

skycfa

right to enter into swap as fixed receiver, floating payer. You would want rates to fall (pay a lower float). If rates fall, bond prices go up and the payoff would be like that of a call option on a bond.

If you want to make a non-callable a callable, then you want rates to fall (theoretically you would then call the bonds at the low rate). by holding a receiver swaption, you received the fixed rate (use it to pay off your fixed rate obligation on the bond), and pay the lower floating rate as if you had called those bonds and reissued at the lower floating rate.

dyga

Thanks a lot guys