Fixed Income

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Joined: Wed Oct 14, 2015 8:10 am

Fixed Income

Postby amandanish882 » Tue Feb 23, 2016 5:03 pm

I have a doubt on callable bonds.

It is mentioned that issuers call a bond when "interest rates" in the market decreases. The issuer can issue other bond at lower interest rate.

I am having a big confusion regarding which interest rate is it ?
Is it the Market interest rate used in as discount rate/YTM? (which results in increase or decrease of bond price)
or is it the Coupon rate of bonds.

Whenever there is market interest rate/market rate mentioned, I get always confused whether it is coupon rate or discount rate/YTM. How to distinguish?


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Re: Fixed Income

Postby edupristine » Mon Feb 29, 2016 9:29 am

There are two interest rates which defines the price of a bond includes: Market interest rate and Coupon rate or market rate at the time of issuance(Zero coupon bonds).
Let's discuss it with an example: There is a bond having a coupon rate = 10% and also market rate at the time of issuance = 10%. Somehow after 6 months market rates have declined to 9%(Depending upon the Macro Economics factors). Now, By declining the market rates the Government started bearing losses because they are paying 10% coupon interest on bonds.

So, If in this case the Government has the call option they will call back the bonds and they will reissue it with 9% coupon rate.

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