Interest rates on enbedded bonds interest, increase, decrease, like

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Hi guys,
i like to seek some confirmation if my understanding is correct.

When there is a rise in volatility,
1) it increase value of call option and decrease market value of callable bond
2) increase value of put option and decrease market value of put bond

As for the rise in interest rates, it decrease the value of putable bonds and increase the value of callable bonds.

Am i right?

ogoluwa

Your understanding is not quite correct... generally speaking a rise in volatility increase the value of an option, both for a call and a put.

--> for a callable bond the buyer of the bond is short an option, so with an increase in vol the value of the bond decreases
--> for a puttable bond the buyer of the bond is long the option, so with an increase in vol the value of the bond will increase

A rise in interest rates will increase the value of a call and decrease the value of a put... but the question of how it applies to the value of a callable/puttable is tricky because not only the option component of the bond changes, but also the bond component.

rgonzalez

Thanks for the input...

koba

Won't puttable bond have higher price than any other comparable bond if interest rate goes up? And callable bond lowest price as per the yield curve considering negative convexity? Voltility is different, you guys explained it well.