## Price-yield relationship of a callable bond, Financial Management

Assignment Help:

Price-Yield Relationship of a Callable Bond

The price-yield relationship of a non-callable or a non-puttable bond is convex because price and yield are inversely proportional. Figure 2 shows the price-yield relationship of a bond when it is callable and non-callable. The non-convex nature of a callable bond can be explained as follows.

From the definition of the callable bond, we know that a bond becomes callable only when the prevailing market yield is less than the coupon rate on comparable bonds. The price-yield curve of a bond is unaffected till the time it becomes callable. Investors may not be willing to pay the same price for a bond even when the coupon rate on the bond is just lower than the market yield as what would have been its price if it were a callable bond, for there is a possibility of a further drop in the market yield and the issuer may call the bond. As yields decline, there is an increasing possibility of the issuer calling the bond. Though the exact yield level at which the bond would be called may not be known, but the existence of such a level is certain. In Figure 2, for yield levels below y*, the price-yield relationship of a callable bond differs from that of a non-callable bond. For instance, the market yield is such that a bond would be selling for 107. But if it is a callable bond then it might be called at 105 and hence the investors will not be willing to pay 107. Even if the investors purchase at 107 and if the bond is called, then they get only 105 and hence there is a loss of 2 units per bond. For a range of yields below y*, there is price compression. Hereby price compression we mean that as yields decline price appreciation is limited. This portion of the price-yield relationship of a callable bond below y* is termed negatively convex because of the following reason. Increase in yields by a given number of basis points will result in a greater price decline compared to the price appreciation if yields decline by the same number of basis points.

#### Financial accounting, Briefly explain the accounting concepts which guide t...

Briefly explain the accounting concepts which guide the accountant at the recording stage.

#### Hedged and unhedged returns on equity and bond portfolios, Question 1: ...

Question 1: i) Discuss the benefits of international diversification and the issue of home country's bias in equity and bonds markets? ii) Explain carefully the currency he

#### Types of t-bills, Types of T-Bills In the US markets, though there ar...

Types of T-Bills In the US markets, though there are many types of T-bills, they can be broadly classified into two types - regular-series bills and irregular-series bills.

#### Evaluate optimum price of the new machine, Q. Evaluate optimum price of the...

Q. Evaluate optimum price of the new machine? The optimum price will be the one which optimises total contribution over the five-year life of the new machine. Sales price o

#### Explain the term present value of the firm''s operations, Explain the term ...

Explain the term "present value of the firm's operations" (also known as Enterprise Value ).  What does this number represent? The present value of the company's free cash flo

#### Understanding financial metrics and business risk, Controlling is an essent...

Controlling is an essential management function as efficient control mechanisms ensure that the performance of the company increases over time through the incorporation of feedback

#### Illustrate the nature of financial management, Q. Illustrate the Nature of ...

Q. Illustrate the Nature of Financial Management? Less Descriptive as well as More Analytical: - Financial management is less descriptive and more analytical. Because of the

#### Accounts receivable are sometimes not collected, Accounts receivable are so...

Accounts receivable are sometimes not collected.Why do companies extend trade credit when they could insist on cash for all sales? Extending trade credit almost for all the tim

#### Evaluation of change in credit policy, Evaluation of change in credit polic...

Evaluation of change in credit policy Current average collection period = 30 + 10 = 40 days Current accounts receivable = 6m × 40/ 365 = \$657534 The Average collection pe

#### Establish budgets and allocate funds, 1. Allocate resources to different de...

1. Allocate resources to different departments by taking information from previous financial data. 2. What would be the estimated cost of new allotted resources to be included i