“…being long a callable fixed-rate bond can be viewed as being long a straight fixed-rate bond and short a receiver swaption.”
(Institute 405) Institute, CFA. 2018 CFA Program Level II Volume 5 Fixed Income and Derivatives. CFA Institute, 07/2017. VitalBook file.
(1) How does one explain a short position on a receiver swaption? Does it mean I do not receive the fixed rate because I am short on it?
(2) How does a short position on a receiver swaption create or assist in creating the feature of the fixed-rate bond being callable?
I’m answering both the questions together
Let’s understand the 3 things here
A)Long callable fixed rate bond will give keep on giving you fixed return until it’s called by the issuer then have to give the bond back. Hence, if it is called you stop getting the fixed return.
B) The short position on the receiver swaption is the party which has to pay fixed return if the swaption is exercised by the long party.
C) Long non-callable bond will keep on giving you fixed retun.
So by combining B) and C) … In C) you can keep getting fixed return but once B) is exercised by long you will also be paying the fixed return which will nullify your fixed return from C on that day onwarsds.
Can you see now the situation is just like A)
Long callable bond will be called when interest rate decrease and a long party will also exercise the receiver sawption when the interest rate decline
Cheers !
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Thanks for clarifying. My understanding is now crystal clear!
Best explanation I’ve seen on this topic. Thanks.
