Options & Par Rates

Hello,

Can someone please further clarify the following two statements:

’Callable bonds are sensitive to par rates corresponding to their call date (particularly if their coupon is high).'

’Callable bonds are sensitive to par rates corresponding to their maturity date (particularly if their coupon is low).'

I cannot find this area in the CFA or Schweser curriculum.

Thanks,

Rex

Suppose that you have a 10-year bond, callable after 5 years.

It will have a very high 5-year key rate duration and a very high 10-year key rate duration.

All other key rate durations will be quite low.

Thanks Bill,

To confirm then:

Durations are highest at callable dates - but why specifically for higher coupons?. Durations are also highest at the end of the maturity (is this because the majority of your payment comes back here? Par + Coupon? - Also why is this more applicable for low coupons?)

You’re welcome.

High coupon bonds are more likely to be called than low coupon bonds, so there’s a greater chance that you’ll get your money back on the call date.

Yes.

Think about Macaulay duration: The larger the cash flow, the higher the weight on the time to that cash flow.

Low coupon bonds are less likely to be called than high coupon bonds, so there’s a greater chance that you’ll get your money back on the maturity date.

Thank you for the summary!

You’re welcome.