Why are option embedded bonds not interest rate dependent? And why are abs,mbs ir dependent? The schweser notes stink at explain this
ABS and MBS - when the interest rate falls - the investor would have a big prerogative to “refinance” his loan – so any changes in the interest rate esp. falls makes the ABS, MBS Interest rate dependent - and causes the prepayment risk for the issuer. Path makes a issue here - because e.g. if rates went from 9% to 7% (refinance here for those who qualified) then rate moved to 10% then back to 7% again (now there would be fewer refinancers here). Bond options are at a price - e.g. company (issuer) decides to call its bonds at say 102$ (this would be in case the bond prices are expected to increase in future) or investor decides to put bond at 100$ - when he expects bond prices to fall. These events are not interest rate path dependent - they are dependent on the current level of interest rate, but not how we got there.
You the man cp. Thanks for the explanation
cpk123 Wrote: ------------------------------------------------------- > ABS and MBS - when the interest rate falls - the > investor would have a big prerogative to > “refinance” his loan – so any changes in the > interest rate esp. falls makes the ABS, MBS > Interest rate dependent - and causes the > prepayment risk for the issuer. Path makes a issue > here - because e.g. if rates went from 9% to 7% > (refinance here for those who qualified) then rate > moved to 10% then back to 7% again (now there > would be fewer refinancers here). also known as prepayment burnout syndrome… 