Callable bond (binomial tree) question

CFA Level II
#1

When looking at the callable bond questions in the schweser practice exams (exam 1am, question #48; and exam 2 am, question #1), i noticed that #48 answer capped the bonds price at the call price and question #1 allowed the bond price to drift higher than the call price. Is the reason why the first one was capped at 100% of par because question #48 indicated that the issuer would call it whenever the price reached the call price, while question #1 did not specify this? Thanks.

#2

i don’t have that test in front of me, but prob b/c it says callable in year XXXX (which maybe isn’t for a year or 2)? so the thing gets capped out further out on the tree, but as you work backwards towards your first node, it may not get capped. tell me if that’s not it and i can go to the other room of my apt and find my book 6 book.

#3

The only difference between the two questions is that one says that the issuer will call the bond if the price hits the call price, and the other question makes no mention of this. The only reason I can come up with is that because of this distinction, the bond is capped at the call price. What do you think?

#4

hang, i’ll get my book.

#5

Thx…

#6

2nd paragraph in exam 2a- "she uses this tree to value a 2 yr 6% coupon bond with annual coupon payments THAT IS CALLABLE IN ONE YEAR at 99.5. watch out for when it becomes callable like i said. in t = 0 which you’re trying to get, not callable yet- if it were callable from the start then you’re right- it’d be 99.5 as the value not the 101 and change.

#7

Ok, so it really matters on when the bond is callable. For purposes of seeing future questions like this, if the bond is not callable at time= 0, then the bond can be above the call price…however, if the bond is callable at anytime, it is capped at the call price. This makes sense. Thanks.

#8

no prob and yes- it matters bigtime when it’s callable. in real life, most are issued and callable in 5 years. in CFA world, that would be one long*ss messy binomial tree! be very, very careful to note when it becomes callable/putable.

#9

you can say longass.