"Fixed Income":callable bond

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Questions 1:

In a low interest rate environment, the effective duration of a callable bond relative to a comparable non-callable bond, will most likely be:

A 、higher.

B 、lower.

C、 the same.

Questions 2:

A bond has a Macaulay duration of 6.0, modified duration of 6.5, and convexity of 50.25. If the bond’s yield to maturity decreases by 50 bps, the expected percentage price change is closest to:

A、 3.06%.

B 、3.31%.

C、 3.25%.

View answer resolution

【Answer to question 1】B

【analysis】

B is correct. When interest rates are low, the callable bond’s price will not increase as much because the presence of the call option will limit the price increase. Because the bond is likely to be called when interest rates are falling, the embedded call option will reduce the effective duration of the bond. A is incorrect because in a falling interest rate environment the effective duration of a callable bond will be lower, not higher, than the effective duration of a comparable non-callable bond. C is incorrect because in a falling interest rate environment the effective duration of a callable bond will be lower than the effective duration of a comparable non-callable bond.

【Answer to question 2】B

【analysis】

B is correct. The expected percentage price change for a bond can be is estimated as follows:

Fixed Income:callable bond