kkn006

VCallableBond=VNonCallAbleBond - VCall.

Interest Rate increase - VNonCallableBond decreases.
VCall Increases (as above)

so VCallableBond decreases

VPutableBond = VNonPutableBond + VPut

VNonPutableBond decreases
VPut Decreases as well.

So VPutableBond decreases.

CP

tarunajwani

CPK--

Your claim is the when rates increase, Vcallable and Vnoncallable decrease and Vcall increase.

The answer to the Schweser question says that Vcallable and Vnoncallable decrases, and Vcall decreases as well.

Are you saying they are wrong?

MiniMe7

Yes,

Vbond = Vnoncallable - Vcall ... that is what I meant.

I agree Vcall should increase due to an increase in Int rates.

kickthatcfa

bought callable bond is equal to bought straight bond and sold call option (sold right to buy the straight bond).

the value of the straight bond goes down when rates go up. therefore the value of the call bond option decreases.

or

the probability that the issuer exercises the option (calls the bond) goes down when rates go up. when probability of exercise goes down the value of option goes down

ok?

defour44

As the risk free rate increase the price of a call option increase. the price of a PUT option decreases.

the value of the bond would decrease:

Vbond = vnoncallable - vcallable

as vcallable increases, vbond decreases.

Am I off on this, I thought this was an area I had down pretty well so I think I'm right.

bbtomato

okay i see what u are saying.

lets go back to put call parity to get value of call option.

C = P + S - X/ (1+r)

If interest rates go up, last component goes down and C goes up.

But with interest rates going up, S the spot price comes down(intrinsic characteristic of the underlying in this case). So, C goes down.

since these are contradicting effects, look like we cannot predict the value of embedded call option with interest rate movements then.

yalo

interesting, lets have a look at this:

S = F / (1+r) , where F is forward price of a bond

when rates go up (parallel shift pls), forward price goes down.

rewrite the parity:

C = P + (F - X)/(1+r)

the difference is discounted by higher rate so the PV up, but F will be probably higher amount than the difference therefore the effect will be that it all goes down. On top of that time to expiry will be probably shorter than bond tenor from expiry time.

btw, P will go up (do not forget about put value) but the delta of put option is lower (in abs) than delta of S (or F)

giants2010

1. Correct
2. Correct
3. Correct

SpyAli

1. Correct
2. Correct
3. Kinda correct.
------> Interest rates go up, Value callable goes down (because bond prices are inversely related to interest rates AND the value of the call goes up which reduces the callable bond, so you got two things going here), Value call goes up (who owns the call? the issuing company), Value noncallable goes down.

Don't confuse with "volatility" of rates increasing and "interest rates" increasing. These are two different things, but can happen simultaneously.

Best in June!

profil

Yes, missed out on Vcall in the 3rd point. Vcall will go up. Totally agree with david.