Components of a callable bond, Financial Management

Assignment Help:

A callable bond is 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 a callable bondholder is given by,

         Value of the callable bond   =       Value of the non-callable bond - Value of the call option. 

It can be seen in Figure 1 that the difference between the price of the non-callable bond and the callable bond is the price of the embedded call option. Though we have simplified the situation for explanatory purposes, in practice it is not easy to define the price of a callable bond like this. The issuer may call the bond at the first call date or any time thereafter or any subsequent coupon anniversary. Thus, the investor has sold a strip of call options to the issuer. The price of the call option may vary with the date the option is exercised by the issuer. But it is always easier to describe the investor's position as a combination of a long position in non-callable bond and a short call option.


Related Discussions:- Components of a callable bond

First, how do you calculate the current ratio

how do you calculate the current ratio

Examine about environmental analysis, Examine about Environmental (external...

Examine about Environmental (external) analysis "A study that considers potential environmental effects during planning phase before an investment is made or an operation start

Coupon curve duration, Market price is used for determining the dura...

Market price is used for determining the duration of a mortgage-backed security in the coupon curve duration. This approach to calculate the duration of mortgage-bac

Borrowing funds via repurchase agreements, Repurchase agreement is a ...

Repurchase agreement is a contract wherein the seller of a security agrees to buy back the same security from the purchaser at a specified price and time. It is also

Relationship between financial decision making and risk , Discuss the relat...

Discuss the relationship between financial decision making and risk and return. Would all financial managers view risk-return tradeoffs similarly

Lockbox system, how do we compute for benefits can derrive out of using loc...

how do we compute for benefits can derrive out of using lockbox system?

What are the components of return, What are the Components of Return Re...

What are the Components of Return Return is fundamentally made up of two components: Periodic cash receipts or income on the investment in the form of interest,

Liquidity risk, An investor, who wants to sell a bond even before it ...

An investor, who wants to sell a bond even before it reaches its maturity date, would be concerned as to whether he will receive a price that is close to the true

Cost of capital, The Nu-Nu Brothers Inc. (NNBI) has the following capital s...

The Nu-Nu Brothers Inc. (NNBI) has the following capital structure, which it considers to be optional: Debt 25% Preferred Stock 15% Common Equity 60% NNBI''''s expected net income

Compare diversifiable and nondiversifiable risk, Compare diversifiable and ...

Compare diversifiable and nondiversifiable risk. Which do you think is more important to financial managers in business firms? Diversifiable risk is able to be dealt with by of

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd