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Unformatted text preview: Callable Bonds (section 6.4) Callable bonds are bonds that a bond issuer can pay back before the redemption date • bond issuer will do so if interest rates fall • they will replace the old bond issue with a new series of bonds which pay a lower bond interest rate From the investor’s point of view: • the time to redemption is uncertain • need to determine the price to pay to insure the investor earns the desired yield rate Example 6.4.1 A $2000 bond with semiannual coupons at j 2 = 8% is redeemable at par in 10 years. It is callable after 5 years. Determine the price an investor should pay to guarantee a yield of (a) j 2 = 7% (b) j 2 = 9% Solution to 6.4.1 For both (a) and (b), you need to calculate two prices: • assuming bond is held to maturity • assuming bond is called early In General – For bonds callable at par 1. If i < r (bond sells at a premium), use the earliest possible call date in your price calculations 2. If i > r (bond sells at a discount), use the latest possible redemption date in your price calculations However For bonds that are callable at a premium, we cannot use the above rules • we must calculate the various prices and pay the lowest one Example 6.4.2 A $2000 bond at j 2 = 7% is redeemable at par in 20 years. It is callable at a 5% premium in 15 years. Determine the price to guarantee a yield of j 2 = 6%. Solution to 6.4.2 Price of a Bond Between Bond Interest Dates (section 6.5) So far we have been calculating the price of a bond assuming the bond was purchased on a bond coupon date • in these cases, the seller keeps the coupon due on that date and the buyer receives all future coupons However, bonds can be bought/sold at any time In order to determine the price at which the bond can be sold, we need to determine how much of the next coupon • “belongs” to the seller • “belongs” to the buyer Notation...
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This note was uploaded on 04/14/2010 for the course ACSCI 2053 taught by Professor Kopp during the Spring '09 term at UWO.
 Spring '09
 Kopp

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