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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 investors 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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