I have two questions on derivative.
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Why callable bond with low coupon are unlikely to be called?
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The maturity-matched par rate is the only rate that affect the bond value. Why?
Thank you!
I’m half-asleep and can’t process number 2 right now.
- Bonds are called when rates FALL lower then they were at issue. So by calling the issuer can reissue at a lower coupon. Say rates were at .1% (extreme, I know). It’s unlikely that will be called because it’s unlikely that rates will ever drop below that to make it worthwhile. If a callable bond had a 10% coupon, it’s much more likely rates go to something like 3% (lots of room to drop), at which point it would be called (or would have been way before).
Flip the concept for Putable. A high coupon Putable bond probably won’t be put. Why? Rates were so high when it was issued. It’s unlikely they will be higher and be beneficial for me to put my bond and get another.
Does that help?
If you’re paying a 1% coupon, why would you call the bonds? So that you can have the privilege of paying a 2% coupon?
I presume that you mean that for a bond selling at par, the only nonzero key rate duration is the one at the bond’s maturity.
It has to do with the mathematics of computing key rate durations – changing one par rate while keeping all others unchanged – which is fairly complex. As long as you know that that’s the only nonzero key rate duration for a par bond, you’re fine.
You’re welcome.
Hi harrygo,
Your Question #1 has been answered nicely below.
Answer for Question #2: If an option-free bond is trading at par, the bond’s maturity- matched rate is the only rate that affects the bond’s value. Its maturity-matched key rate duration is the same as its effective duration, and all other key rate durations are zero.
I presume that if you and I were in the same hemisphere, it would have been answered nicely _ above _.
Hi S2000magician,
Sorry, You had answered both Questions very nicely. I only added my 1 cent. I have a very long way to go before I can even stand in front of you. You are very knowledgeable. Hats off to you. Thanks for everything you do for this Forum. 
