 # Q. callable bond price decrease vs. optional free bond.

V5- 97 If market interest rates rise, the price of a callable bond, compared to an otherwise identical option-free bond, will most likely: Select exactly 1 answer(s) from the following: A. increase by less than the option-free bond. B. decrease by less than the option-free bond. C. decrease by more than the option-free bond. D. decrease by the same amount as the option-free bond. ----------------------------------------------------------- my guess: D "when the call date is far away, D is right. When call date is close, and the rate is very low, B is right. I think this Q is not accurate enough. Depends on the call feature and how much the call is in/out of the money. Value of callable is value noncallable minus value of a call option, so if call value changes when yield changes (which is does), change in price of callable cannot be the same as price change of non callable. Please see Price-Yield function of callable vs. option-free bond. (Figure 2 on P. 141 of schweser Book 5) and note that shape of price yield relation for callable and option-free are quite different.

B think graphs!!!

D should be the best answer

C. As they the callable bond will have positive convexity.

Interest rates rise, bond with an option acts like an option free bond.

ooooppps. I am wrong. I think correct answer is D.

pepp Wrote: ------------------------------------------------------- > ooooppps. I am wrong. I think correct answer is D. why?

If interest rate rise, the price of the bond will go down, and hence there is high probability that the issuer will call the bond.

umm… god, i think i knew how to answer this… nowi am getting all confused.

image the graph of bond price and yield, I think it is B, callable bond decrease always than option free bond. the call option always has some value.

It is C. Because of the positive convexity, the price will decrease by more the option free bond.

strangedays Wrote: ------------------------------------------------------- > If interest rate rise, the price of the bond will > go down, and hence there is high probability that > the issuer will call the bond. what are you talking about???

also image the graph of putable bond vs. option free bond. when interest raise, putable bond decrease less too.

what’s the real answer?

annexguy Wrote: ------------------------------------------------------- > also image the graph of putable bond vs. option > free bond. > when interest raise, putable bond decrease less > too. When interest rate rise decline in vale of putable bond will be slower than that of a similar option free bond. But when interest rates drop, put options behave like option free bond. What is the official ans ?

if interest rates are rising, issue is more likely to be called. hence the option value of call goes up. a) price of callable bond = b) price of option free bond - c) price of call option so if int. rates go up, then b goes down, but c goes up as a result part of b downside is offseted by c, hence price of callable bond won’t fall just as much as price of option free bond will fall. So the correct answer as I said in my first post (without thinking) is B. Strange days, if interest rates FALL, a bond will be called b/c the company wants to issue new debt at a lower rate…you confused that with prices falling.

but price of call option goes down if int rates goes up… my guess is D

Believe me, if a company is paying a 10% and rates are low and they can reissue at 4%, they will call that bond and reissue at 4%.

OK, so… If market interest rates rise, the issuer’s right to call the bond is worthless because there will be no cost saving to the issuer from calling the bond. The price of the callable bond willbe equal to the price of the non-callable bond with the same feature. Hence: D. decrease by the same amount as the option-free bond. is the correct answer.