“Callable bonds have less downside potential when the call option is out of the money and in a rising interest rate environment”
How is the above statement not true. Since callable bonds have more upside potential than putable bonds in a rising interest rate environment, this would imply that they would have lower downside potential in a rising interest rate environment vs. putable bonds.
Or is this an example of me thinking about the question too much?
When a callable bond is out of the money, it means the likelihood of it being called is low. Now if interest rates are rising, then it is getting farther out of the money. So this bond would behave close to a option-free bond. Why would it have less downside potential?
based on the fact that callable bonds have more upside potential when interest rates are rising than putable bonds.
At least that is what I read in one of the Kaplan question. So having more upside potential when interest rates rise means it will have less downside potential (the way my logic works).
Actually 125mph is right… when Int rates rise… bond prices drop (coz people want to get rid of a bond paying a lower return and invest in a more lucrative bond)
It literally says in the text…" In contrast, when interest rates rise, callable bonds have more upside potential than otherwise identical putable bonds."
Which would imply it has less downside potential when interest rates are rising vs. putable bonds
It doesn’t make sense to be either but i guess the CFA wants us to know it this way…
And it literally says _ in the errata _: " Reading 37: In the paragraph just before Example 7 (page 158 of print), replace the last sentence with ‘Putable bonds also have less downside risk than otherwise identical callable bonds when interest rates rise.’"
Bad guess.
So there was an error in the reading? I am assuming that is what errata means because I cannot find that in the text (looking right above example 7 pg. 158 in the CFAI textbook).
This was already answered in your post just last week… you don’t read responses to your posts?
https://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91364769
my apologies, did not even see that.
Should have looked back at that.
thanks