Schweser 2017 pratice exams volume 2, exam 2 afternoon session question 30 p101:
Scenario A: Interest rates are near coupon rates and fall for both callable and non-callable bonds by the same amount
Scenario B: Interest rates are historically very low and rise for both callables and non-callables by the same amount
Question: Which of the following best describes the relative performance of callables and non-callables under the two scenarios:
A) Callables will outperform non-callables under both scenarios
B) Callables will outperform non-callables under scenario A only
C) Callables will outperform non-callables under scenario B only
I got B, since callable bonds exhibit negative convexity they will outperform if rate are low and rising.
The answer in the answer key is C with the eplanation being:
When interest rates are near coupon rates and fall for callables and non-callables, non-callables will increase in value more than callables. This is because the price of a callable is depressed as the value of the embedded option increases with the drop in interest rates. Under Scenario A, therefore, non-callables outperform callables
When interest rates are historically low and rise for both callables and non-callables, the value of the non-callable will fall faster than the value of the callable. Therefore, under scenario B the callable will outperform the non-callable.
Am i missing something here, it seems they are contradicting themselves. Can anyone help out? Thank you