Valuation and duration of callable bonds , Financial Management

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A callable bond is similar to an Option-free bond with a call option from the bondholder. It can be thought of as the sale of a call option by the investor to the issuer as it allows the issuer to repurchase the bond from the time it becomes callable until the maturity date. The purchaser of a callable bond effectively enters into two transactions.

  1. Purchase of a non-callable bond for which they pay some price.

  2. Sale of a call option to the issuer for which they receive the option price from him.

The net price paid by the callable bondholder is given by,

         Price of the callable bond = Price of the non-callable bond

                                                             - Price of the call option.

         Value of callable option = Value of an option-free bond

                                                           - Value of a call option on the bond.                  


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