from schweser: “Put structures fare better in environments where interest rates are NOT expected to decrease. Holders of putable bonds have the ability to put the bond to the issuer and seek out higher yielding investments. If interest rates decline, putable bonds tend to underperform nonputable issues” Im confused here. If interest rates decline, bond prices rise, and yields decline, therefore shouldnt putable bonds be more in DEMAND at this point which would cause them to outperform nonputables ? Can someone please explain the mechanics Very much appreciated
i would have thought that when yields rise the put option would put a floor under the price - resulting in lower convexity (the slope of the tangent falls toward zero at the strike yield) - so putables should out-perform straight bonds (or callables) when yields are rising. So when yields are falling they will under-perform straight bonds because the artificial price premium is un-winding - hence price rise slower and by less than the price of a straight bond - hence under-performance hope this makes sense (I’m not a bond person)…
if interest rates decline, the value of the put option goes away. Think about it from the persepctive of the bond holder. Let’s say you own a 5% puttable bond, and interest rates go to 4%. No way you put it back. The put has value when interest rates are rising because you can then excercise the put and seek out higher yielding instruments. As a side note, a lot of the CFA material for bonds is easier to understand if you can visualize yourself holding a bond and figure out what the best move is instead of trying to memorize stuff.