Fixed Income_Spong_Q5

The answer says both callables and putables will outperform bullets given the scenario of low volatility and increasing yields.

How can callables and putables both be preferable at the same time? Aren’t they opposites of each other as per below relationship?

Vc=V-c, Interest rates rise callable underperforms

Vp=V+p, interest rates rise putables outperform

Call option is exactly on issuer side while buyer of bond holds put option.

In the event of rising IR environment both will outperform normal corporate bullets.

Put option will protect in addition from falling bond price.

Call option will not be executed and thus callable would value more than ordinary bullet.

So if I hold two bonds - one callable and one putable, and interest rates rise, the value of both bonds will move in the same direction?

When yields are low, callable bonds have shorter effective duration than straight bonds and putable bonds have essentially the same effective duration as straight bonds.

When yields are high, callable bonds have essentially the same effective duration as straight bonds and putable bonds have shorter effective duration than straight bonds.

So, when yields are rising, both callable and putable bonds will perform at least as well as straight bonds, and may perform better (depending on whether yields are low or high).