Which of the following market conditions would suggest the use of callable bond structures in a corporate bond portfolio? A) Bull bond market. B) Increasing interest rate volatility and a bull bond market. C) Bear bond market.
C
Correct. can you explain why?
Bull Bond market means rates decreasing… due to the negative convexity of a callable, the callable will increase less than a non-callable… The value of a callable = noncallable - option value As volatility increases, so too does the option value, therefore the callable value decreases So in periods of decreasing rates or higher volatility, callables are not preferred… Bear bond markets mean rates rising, so the call option is not valuable
in a bear bond market, bond prices decline (as intrest rates are rising). in such a scenario, call option becomes worthless and as rates rise, callable’s (with -ve convexity) price falls less than that for a treasury (or a security with +ve convexity) for a similar rate increase. hence callables outperfrom in such scenario.
level3aspirant, thanks!
u r welcome.
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