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Study Session 13: Fixed Income: Topics in Fixed Income Analysis

Value of a call within a callable bond

I would like to compute the value of a call within a callable bond

  • The callable bond is a 3-year bond, coupon is 1,5%
  • Available rates in the exercice are par rate, spot rate, and one-year forward

The formula in the book states : value of a call = value of a bond straight – value of a callable bond. So we should compute both the value of the bond straight and value of callable to find the value of the call

Effective duration

Would it be right to say that the effective duration of an option free bond is the lowest as compared to callable and putable bonds, in general? 

If yes, then how would one explain the callable/putable bond exhibiting the price-yield profile of an option free bond when out of the money? 

Long/short CDX clarification

Hi everyone, could you please help me clarify this exercise?

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Now here is my thinking: the curve will steepen, so with a normal bond strategy we would be long short durations and short longer durations. CDX are essentially giving an opposite exposure (buying a CDX is like being short bonds) so I just thought I would reverse my logic and therefore be: short, short duration and long longer durations (answer C). Can you help me clarify here?

Reading 43-practice problem 22

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why would putable option increase when the interest rates decrease, should not the putable bond be further out of the money and accordingly less investors prefer to purchase the putable bond and accordingly the value of the put option should be lower?

who said that a putable bond has an uncapped upside potential!

That question in the cfa book that I do not get it’s answer;

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I do not get the bolded statement, as far as I understand, when u call an option, you have an uncapped upside potential where you gain the difference between the market price-call price - the premium paid. For the putable option I do not get where is the upside potential in case the price increases, should not the option buyer losses??


I have a question regarding the answer!

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If Zega will be bought at a premium, why do not we sell it rather than buy it at a higher price?

Protective short example

This is a question from the credit default swap from the CFA book. I don’t get the answer!

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I would understand that the protection buyer would benefit in case he had purchased it earlier than the two months where he has already paid the upfront premium and will benefit from any increase later on. But if the buyer shorts at the time of the increase of the credit spread, he will pay the difference in the credit spread as an upfront premium. 

Credit Default Swap

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I do not get the following:

1.Does trading at 50% of par mean that the bond is at default and this is the value the bond holder will recieve at default

2.Why would Deem can cash settle for $6 million [= (1 – 40%) × $10 million] on its CDS, does a $10mm CDS mean that the other party pay the difference between the $10mm and the $4mm?

3.In case of physical settlement, why would Deem deliver the bond, is not he the one that should receive the bond back in order to sell it?

Too low vs too high

Ran into a question that gave this in the problem set:

5% Annual VaR = [9.4% - (1.65 × 14.2%] = -14%

5% Daily VaR = [(0.0376% - (1.65 × 0.0568%)] = -0.056%

The question The calculated percentage value for daily VaR in Exhibit 1 is most likely:

A) correct given the assumptions and method described.
B) too high given the assumptions and method described.
C) too low given the assumptions and method described.