Adding and remoning the call feature on callable bonds

This bit is in the back of Volume 5 and you could possibly miss it. To remove the call feature you sell a receiver swapion and to add a call feature you go long on the receiver swaption.

The strike rate on the receiver swaption is set as the rate on the bond less the bond credit spread

Can any one provide a simple explanation on how this is working. Thanks

Have not got to this yet, but I will try.

First part of such a question be it to add a call or to remove a call will be saying if you should buy a payer or receiver.

Without knowing details, if you hold a calable bond, it would get called and you would be screwed, this will happen if rates go down, you would need something that makes you money when rates go down, that thing would be paying variable and getting fixed since you would pay low and get high, that would be accomplished by a receiver swaption.

use inverse logic for adding feature… so here you secured some points by simply knowing what to do

now as far as calculations i have not seen this, so this is just from my head

say it would become attractive for the issuer to call your bond if rates drop to 4%, say they dropped to 2% and the bond got called and you must invest at 2% now. if you hold a reciver swaption that allows you to pay 2% and get 4% , the outcome is kind of teh same for you, called or not…

i hope this helps

receiver swaption is used to hedge the interest rate risk, not credit risk. So the strike rate is bond yield less credit spread.

The strike rate is probably just an industrial convention…To hedge a position, you can choose any strike price. Different prices have different delta’s.

i know. i missed it twice during my study cycle.

receiver swaption is a call option.

if you already have a callable bond, you own a call option already. to remove the option, you sell a call option (receiver swaption at a strike spread of Spread-credit)

if you have a non callable bond, you do not have a call option. if you want to make it callable, then you buy a receiver swaption which is really a call option.