Q. Which of the following statements is least accurate?
A. Putable bonds always exhibit positive convexity.
B. Putable bonds have greater upside potential than otherwise similar callable bonds when interest rates fall.
C. The upside for a putable bond is much larger than the downside when the put option is out of the money.
The answer is C. What’s so lesser accurate about it?
When interest rates decline putable bonds’ value increases similar to a straight bond there is no cap on upside potential…
however when interest rates increase putable bond has less downside due to activation of put option which is likely to exercised (floor on bond value is guaranteed)
Put option guarantees a floor on the bond price therefore increase in interest has a less downside to puttable bond’s value
increase in value due has decline in interest rate has no cap
Precisely my point.
the downside/upside potential should be matched to its duration if the put is OUT of the money. Statement C would be correct if it read “IN THE MONEY”