Two questions on fixed income securities

[archived_user]

I have two questions on derivative.
1) Why callable bond with low coupon are unlikely to be called?
2) The maturity-matched par rate is the only rate that affect the bond value. Why?
Thank you!

 

[archived_user]

I’m half-asleep and can’t process number 2 right now.
1) Bonds are called when rates FALL lower then they were at issue. So by calling the issuer can reissue at a lower coupon. Say rates were at .1% (extreme, I know). It’s unlikely that will be called because it’s unlikely that rates will ever drop below that to make it worthwhile. If a callable bond had a 10% coupon, it’s much more likely rates go to something like 3% (lots of room to drop), at which point it would be called (or would have been way before).
Flip the concept for Putable. A high coupon Putable bond probably won’t be put. Why? Rates were so high when it was issued. It’s unlikely they will be higher and be beneficial for me to put my bond and get another.
Does that help?

 

[archived_user]

harrygo wrote: I have two questions on derivative.
1) Why callable bond with low coupon are unlikely to be called?

If you’re paying a 1% coupon, why would you call the bonds? So that you can have the privilege of paying a 2% coupon?

harrygo wrote: 2) The maturity-matched par rate is the only rate that affect the bond value. Why?

I presume that you mean that for a bond selling at par, the only nonzero key rate duration is the one at the bond’s maturity.
It has to do with the mathematics of computing key rate durations – changing one par rate while keeping all others unchanged – which is fairly complex. As long as you know that that’s the only nonzero key rate duration for a par bond, you’re fine.

harrygo wrote: Thank you!

You’re welcome.