Why do you they give you a callable at 100, when the call price is 104? When developing a binomial tree (correct me if I am wrong) but the bond would only be called if the price is > than the call price…so what is the point of telling me it is callable at 100…am I missing something?
Not sure if you have a specific example you are referring to, but the call price is 100, that’s the value used in the node if the computed price is greater than the call price (as it will be called away).
The root value of the tree (104) may be greater than the call price because it’s a dirty price (i.e. includes the coupon).
Also, just because it’s not going to get called today doesn’t mean that it’s not going to get called in the future. As interest rates in the tree rise, the price will decline.
I should have given an example, I will just make one up: An investor purchased a callable bond, which is callable at par and will pay 102 (yes, a slight call premium to compensate the investor when called).
Tree node has the bond price of 100… what do you do? From your response it seems like you would put the value 102 in the node…this is where I am confused. I cant find a specific example on this, but I am guessing the call price is the greater of the two, 102, and would assume the bond wouldn’t get called at 100 and would only get called when the value hits anything > 102…can someone correct me if I am wrong?
I added an example to help better illustrate what I was trying to say…
i don’t believe there is such a bond like this (which is perhaps why you can’t find an example).
There’s a call price, which is 102, and that value should go in the node as appropriate. “Callable at par” doesn’t mean anything if there’s a separate call price since it’s saying the same thing.
In the situation you describe, why would a company buy back its debt at 102, when it’s trading at par…
The 2 could be accrued interest (given bonds are usually callable only on their payment dates), if this is something you’ve seen in a specific example.