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The yield investors had sacrificed for protection against higher interest rates instead constrained total return as rates fell.
At lower yields, the putable bond has a price-yield relationship that is similar to the option-free bond. So you end up having earned a lower price appreciation compared to the vanilla bond, which leaves you worse on a total Return basis. There is no premium paid to putable bonds. Putable bonds offer a lower coupon than option-free bonds given that they provide a long option to bondholders. As a result, these bonds are not as sensitive to interest rates and when the interest rates decline, they will offer less price appreciation.
On a side note, putable bonds are extremely rare in the market place, which makes it tricky to assess price movements given few data points historically. I think its as simple as: As the above poster said, putable bonds offer a lower coupon than a plain vanilla given the option available to bond holders.
So in an environment where rates fall, putable bonds under-perform compared to plain vanillas because of the lower yield and the reduced value of the option. Both must be equal in pv terms. My post was an upfront premium the other poster had a As you go premium. Take a look at V5 R43, the end of that reading. It briefly describes using a payer swaption for an issuer wanting to synthetically embed a put feature onto a bond by selling recieving a premium for the receiver swaption.
More important, it goes through how to syntheiticallly add calls onto a bond, probably more likely to show up on the exam. Let us assume there is a 5-year putable bond and there is another 5-year option free bond. Both have the same credit rating from the same issuer. Which of these two bonds will you buy when interest rates are falling? Also remember that the chances of default generally reduce with falling rates because of several factors opportunity to refinance, lower rates boost economic activities, etc.
With the option of buying any of the two bonds, you will prefer the one with a higher yield, which is the option free one. All rational portfolio managers will go for the option free bond and this will make it outperform the putable bond. Skip to main content. Be prepared with Kaplan Schweser. Please explain the logic.. With exam day right around the corner, Schweser's Final Review products are designed to help you finish out your study plan and walk into the testing center feeling prepared and confident.
IRS-Trader Dec 22nd, 9: I can understand the logic! IRS-Trader Dec 22nd, Manet Take a look at V5 R43, the end of that reading. Char-Lee Dec 23rd, 1: This is as simple as I think I can make it.