In general, if interest rates rise, will the price of a bond with an embedded call option drop more quickly or more slowly than an ordinary bond? I am reading some Stalla material and the expected result is unclear to me. Any insight is greatly appreciated.
Less due to lower effective duration.
Thank you - that’s what I thought. At an interest rate point past negative convexity, the downward sloping yield curve mirrors that of an ordinary bond. Somebody was trying to convince me otherwise.
i thought it was more quickly since it will likely be refinanced at the lower interest rate; i may be mistaken though…just started preparing.
ah…read it wrong. my mistake :).
Issuer holds right to call…not in issuer’s best interests to call during rising/higher rates.
The effective convexity is negative for a callable bond a low rates. At high rates, the option is out of the money and the convexity is positive just like a non option bearing bond. There should be no difference between the two bonds at high rates, only at low rates.
I think doseweissen is correct. Is the lower duration due to the higher yield on the option w/ the embedded call, shorter expected life, both? We recently debated this issue (see the thread below), but I’d value additional insight. http://www.analystforum.com/phorums/read.php?11,626468,626468#msg-626468