fixed income- callable bond

问题如下：

The conversation next turns to the state of the economy. Another member of Thorn’s team, David Yung, concludes that the economy will weaken, causing the yield curve to experience a downward parallel shift. Yung proposes two trades.

l Trade 1: Sell a 5-year A-rated callable corporate bond, Buy a 5-year A-rated non-callable bond of the same issuer

l Trade 2: Sell a 10-year fixed-rate corporate bond, Buy a 10-year floating-rate bond of the same issuer

Determine, given Yung’s conclusions, whether each of his proposed trades would most likely be profitable. Justify each response.

选项：

解释：

Correct Answer:

Trade 1 should be executed. Interest rates decline when the economy weakens. Due to negative convexity, callable bonds underperform non-callable bonds during periods of declining interest rates. Callable bonds have a price limit imposed by the call price. Consequently, the bond would most likely be called when rates decline. The trade will, therefore, be profitable.

Trade 2 should not be executed. Given Yung’s economic outlook and anticipation of a parallel downward shift in the yield curve, duration should be increased, not decreased. Fixed-rate bonds have higher duration than floating-rate bonds as coupons are fixed rather than adjusting periodically to market interest rates. Selling higher-duration bonds to invest in lower-duration bonds as rates decline would not be appropriate.