Hi, all. R43 P.519 CFAI “A receiver swaption is equivalent to a call option on a bond.” the right to receive fixed is equivalent to the right to buy back a bond for the issuer??? Anyone can explain the concept? Thanks in advance!
Right to receive Fixed happens when the Strike rate > Fixed Rate of the Swap on which the option (Swaption) is created. This would be when the Rates are increasing. Call Option on a Bond - Issuer has the Right to call the bond - when the rates increase so as to make issuance of a new bond cheaper in the new regime - and then it makes sense for the Issuer to retire the existing bond and issue a new one at the lower rate. So both of these are similar…
Bond prices have inverse relationship with interest rates. A call option holder on bonds makes money when interest rates decrease. A fixed rate receiver (floating rate payer) in a swap also makes money with decrease in interest rates. A receiver swaption gives the right to enter into a swap with a right to receive fixed interest rate.
I seem to have written something wrong… was writing this from memory. I have not yet reached this section. so if I am wrong, please ignore.
This is the way I see it: original bond: Issued @ say 8% Call option @ say 110 New Bond: Isued @ say 5% When interest rates fall and you are paying a fixed amount (as in a bond), refinancing (Calling the bond) is like receiving the difference in what you are paying. In the example above the corporation would “receive” (i.e. not pay) $30 per bond each year. To be fully accurate on the savings the issuer would need to factor in the price paid to call the bond as well, but you get the point. Think of people refinancing their house. Most people don’t say “I’m spending X dollars less”, they say “I’ve got X dollars more to spend on something else!” As if they actually receive more money than they used to.
Thanks, cpk123, mitchells, FinNinja !! All explanation is helpful!! thanks again.
Another good one. Is the receiver swaption like a interest rate put option?
deriv108 Wrote: ------------------------------------------------------- > Another good one. > > Is the receiver swaption like a interest rate put > option? Yes. You will benefit from a drop in interest rates for both these instruments.