Urgent - Yield curve flattening on callable/putable bonds

CFA Level II Fixed Income
#1

Apologies if this question was covered elsewhere in the forum.

I am probably missing something very simple, but could somebody please help me reconcile the below two points?

  1. Callable and Putable bonds decline in value when yield curve flattens, as explained below:
  • Vcallable = Vstraight - Vcall
    • The call option gains value when the yield curve flattens
  • Vputable = Vstraight + Vput ​​​
    • The put option looses value when the yield curve flattens
  1. Link According to the value diagrams, the value of callable and putable bonds rises as the yield falls. :frowning_face:

What am I missing? Am I misinterpreting the concept of yield flattening?

Many thanks in advance for your help! I appreciate it might be a silly question.

#2

This is a source of much confusion.

Firstly, when the yield curve flattens the STRAIGHT value rises. The impact of the option however will offset the callable/puttable value.

Your diagram is showing that when the yield curve falls price rises. If price rises the call becomes more in the money, therefore the call value rises. However because a callable bond is SV - Call the overall callable bond will decrease.

#3

I believe you mixed up the CALL and the CALLABLE bond. These move in opposite directions.

In the cases of PUT and PUTABLE bond, these move in the same direction.

recall:

Callable Bond = Straight Bond - Call (holder of Callable Bond does not own the Call, so is DEDUCTED from Straight Value)

Putable Bond = Straight Bond + Put (holder of Putable Bond also owns the PUT, ADDING the put value)

Good luck!