callable bond

[Jovial Guan]

Jam said when interest rates are high, a call is not likely so the callable bond's price is close to the price of non-callable bond.
But I think the interest rates have trends to decrease because it's high currently, when decreasing the issuer would like to call the bond and issue the another bond with lower interest.So the callable option is more important at high rates than at low rates. And the callable bond's price is lower than the non-callable ones.

[Steve Grondin]

Think of it this way.

If the bond's coupon is X, the difference in price of a callable bond and a non-callable bond is smaller at X+3% current yield than at X+2% current yield.

I don't think they are trying to make a statement about the price difference between callable bonds with two different coupons. However, I would tend to agree that the price difference between call/non-call coupon X+3% current yield X+3% would be greater than price difference between call/non-call coupon X%/current yield X%.

[New at pd]

On 2002-03-18 08:10, Jovial Guan wrote:
Jam said when interest rates are high, a call is not likely so the callable bond's price is close to the price of non-callable bond.
But I think the interest rates have trends to decrease because it's high currently, when decreasing the issuer would like to call the bond and issue the another bond with lower interest.So the callable option is more important at high rates than at low rates. And the callable bond's price is lower than the non-callable ones.

All that JAM is saying is that the likelihood of a call when i = 20% is far less than when i = 0%, for example.
He is looking at what rates currently are, not what they may be in the future. This increased likelihood is reflected in the difference between the price of the NC bond and the callable bond, which is larger for lower interest rates.

When you say "But I think the interest rates have trends to decrease because it's high currently, when decreasing the issuer would like to call the bond and issue the another bond with lower interest," you are getting into topics of valuation and simulation that are beyond the scope of the JAM statement you listed above.

That's my opinion. Questions, criticisms, etc. are more than welcome.

<font size=-1>[ This Message was edited by: New at c6 on 2002-03-18 09:14 ]</font>

[Oliver Klozov]

I think of the price of a callable bond as being made up of two components:

Price of an optionless bond minus the price of the call option.

What JAM is saying, is that when interest rates are sufficiently above the coupon rate of the bond, the value of the call option approaches zero. Thus the price of a callable bond approaches the price of an optionless bond.

In other words, what Steve said.

[studyhard]

I think you misunderstood the non-callable bond here. This should be a callable bond(e.g. 10/NC 3yrs) compared to 3yr,10yr non-callable bonds. When i goes up, the option worth more so the price of the callable bond is way below 10 yr non-callable. But it approaches the 3 yr non-callable.So both the statement on Jam and yours are right, but one is talking about 3 yr(Jam), the other is 10yr(you).
Does everyone here agree?

[FIOB]

No, I don't agree. As i goes up the bond is less and less likely to be called, so the call is worth less. I am only guessing, but Jovial Guan may be thinking of it in these terms. If the bond is issued while interest rates are high, the call is worth more than if it is issued while rates are low. I don't think that's what anyone else is talking about. Once the bond is issued, and the call price and the coupon rate are fixed, then as the interest rate rises the call is less likely to be exercised, so the bond behaves more like a noncallable bond.

[New at pd]

Given two bonds with identical properties (coupon, maturity, initial yield, etc.), where one of the bonds is callable, then as rates decline, the price of these two bonds diverges, due to the increased value of the call option. As rates increase, the prices of these bonds converges.

We can also argue that, given two identical callable bonds, where the only difference is the initial yield, that it's more worthwhile and likely for an issuer to call the higher yield bond, which translates into a higher option value.

[Dr T Non-Fan]

How about a real-life, hypothetical example?
Callable bond issued at 8% coupon for 30 years.
After 5 years, interest rates have risen to 15%. The bond is worth some less-than-par amount. (I leave it to the reader.)
Safe to say that the bond is not likely to be called. The option portion of the price (a negative amount) is near 0. Inb other words, it's priced close to a non-callable bond of similar qualities.
Then, over a few years, the interest rate drops to 12%. Is the bond likely to be called? No. More likely? Yes, but only because the interest rates have dropped nearer to the coupon rate. (Even more so by the volatility of this hypothecicity.) Still a ways to go before calling procedure will actually occur. The option portion of price has increased (in a negative way), but the bond price increase is far higher than the option price increase.
In other words, the callable bond's price acts more like a non-callable's when it's not likely to be called.
That sentence pretty much sums it up. I don't know why I wrote the other stuff.

[studyhard]

Sorry about my mistake.I wanted to say i goes down instead of up. Basicly what New at C6 said is what I want to say.

<font size=-1>[ This Message was edited by: C6 2002 on 2002-03-18 12:25 ]</font>