is this statement wrong? where is wrong?(from CFA website Q set
Fixed Income Portfolio Management - Rioja Q6)
Callable bonds provide a spread premium that can be valuable to an investor during periods of high interest rate volatility.
Put structures will provide investors with some protection in the event that interest rates rise sharply but not if the issuer has an unexpected credit event.”
Callable bonds provide a spread premium that can be valuable to an investor during periods of high interest rate volatility. High volatility increases probability of bond to be called by issuer, therefore is unfavorable to the investor. Spread premium is like an option premium, it is the price that the issuer pays to the investor to obtain the right to redeem the bond when interest rates fall, it is fixed and does not vary with level/volatility of interest rates.
Put structures will provide investors with some protection in the event that interest rates rise sharply but not if the issuer has an unexpected credit event. “but not” makes the phrase incorrect. It should have been “and/or”
Thx, i get it for callable
but for putable, if issuer has credit event, its ability to meet the obligation to redeem the bond decrease, so this protection for investor is not there anymore?
In the event that interest rates rise, investor will trigger their put option, thus forcing issuers to buy back their bonds.
Similarly, if issuer has a credit event (for eg. credit downgrade), investor will trigger their put option, thus forcing issuers to buy back their bonds. “The issuer’s ability to meet the obligation will decrease” does not necessarily mean that “the issuer has ZERO ability to meet the obligation”, therefore the protection remains valid as long as the issuer still has some ability to meet the obligation.
The definition of the credit event will be set up at the beginning of the contract, and investors will be smart enough to define a credit event that can happen long before the issuer goes into liquidity crisis…
Thx a lot!