Change in bond price interest rate changes SB/ Callable/Putable bond

CFA Level II Fixed Income
#1

Tom Holland, chief investment officer Zavier Investment Advisors during his meeting with the analysts discusses the impact of weakening economic activity. The equity market values are predicted to decline in the coming year and the negative GDP growth rate of the previous quarters is not expected to improve. Holland wants the investors to consider adding more fixed- income securities to their portfolios and limiting their equity exposure.

Holland observes, “Because of low government yields we should consider investment- grade corporate bonds over government securities. According to the consensus forecast among economists, the central bank is expected to lower interest rates in their upcoming meeting.”

After the meeting, Zandya Coleman, a fixed-income analyst selects the following four fixed- rate investment- grade bonds issued by Bliss Paper Company for investment (Exhibit 1).

Exhibit 1: Bliss Paper Company’s Fixed-Rate Bonds

Bond

Annual Coupon

Type

*Bond X

2.0%

Straight bond

Bond Y

2.0%

Callable at par without a lockout period

Bond Z

2.0%

Putable at par one and two years from now

Bond S

2.0%

Convertible bond: currently out of money

_*_Note: All bonds have a remaining maturity of three years.

Coleman finds that demand for consumer credit is relatively strong, despite other poor macroeconomic indicators. As a result, she believes that volatility in interest rates will increase. Coleman also reads a report from Thomson Crew, a reliable financial and economic information provider, forecasting that the yield curve may invert in the coming months.

Assuming the interest rates forecast is proven accurate, the bond with the smallest price increase is most likely:​

X, Y , Z or S ?

Please explain

#2

Hello ! Can anyone summarise how the Callble and putable bonds behave when interest rate a) goes up b) goes down relative to Straight bond. I have read a topic somewhere else but couldnt get a proper answer.

Thanks

Rohit C

#3

Bond Y with the smallest price to increase?

#4

if volatility in interest rates increase, a straight bond will experience the smallest price increase because straight bonds are unaffected by volatility in interest rates.

My answer is Bond Y.

Kaplan notes:
“The value of a straight bond is affected by changes in the level of interest rates but is unaffected by
changes in the volatility of interest rates.”

#5

The formatting of the question didn’t come out right, so:
Bond X - straight bond
Bond Y - callable bond
Bond Z - putable bond
Bond S - convertible bond

Higher Interest volatility is one of the information given (agree that it does not affect straight bonds, i.e. bond X).

There is also the info that yields are expected to decline due to the cut from central bank. If yields are expected to decline, then issuer call options will be in the money, hence the callable bond price will increase at a decreasing rate (i.e. smallest price change) compared to a straight bond.