Simple callable bond question question, option, price

wilslm

If the yield rises, will the price of a callable bond fall more or less than the price an option free bond?

tango_gs

hold on….just wanted to clarify….the call option detracts from the value of an option free bond….so in that case with an increase in yields…wouldnt the call option always be less than the option free?…and with a decrease in yields the option with the put will always be higher than the option free bond (since the value of a putable bond is more than the value of an option free bond)…the put option shouldn’t ever detract from the value of the bond….so it should always be HIGHER than a similar option free bond…and a call option should always be lower than a similiar option free bond.
could someone please confirm this?

koba

yes that’s also true. the price of the put option falls, taking away from the increase in the bond.

chetan86

thanks jmuc,
is it also true that when yields fall, putable bond prices do not increase as much as option free bond prices?

yuoska

I’m not sure why this is getting so much attention….
From the CFAI text, “…a decline in int. rates will result in an increase in the price of the callable bond but not by as much as the price change of an otherwise comparable optionfree bond.”
“…when int. rates rise, the price of a callable bond will not fall as much as an otherwise optionfree bond. “

ftwcfa

i’ve actually seen that exam question on schweser a few times and qbank….their answer is always that the prices of the option bonds will move similiary to that of the option free in either situation…they never got into more detail…
but i think thats a fair assesment..what you said above…you would assume that there is some economic value of holding the option versus not…so technically yea I think you are right…

NakedPuts2011

alrite but for purposes of an exam question, is what i wrote above true

jarobi04

and im sure that there is a proper answer…which looks at int rate volatility and values the put/call option more mathematically (like the BS does for equity options) than we need for this purpose…i think for now we can just keep it simple and view it as moves to either infinity or 0…

joehogue

i think you have to look at this question from the point of view of moves to 0 and infinity….as the yield increases to infinity, the callable bond and the option free will act similiarly…when the yield decreases to 0, the putable bond will rise in tandem with the callable bond….as you approach 0 and infinity, respectively, the option values converge to zero.

Bad5shah

so in conclusion
when yields rise, callable bond will not fall as much as option free bond
when yeilds fall, putable bond will not rise as much as option free bond
correct?