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The process of valuing a callable bond is similar to that of an option-free bond, except for one thing - when the call option may be exercised by the issuer, the bond value at a node must be changed to reflect the lesser of its values if it is not called and the call price. For illustration purpose, let us consider a 5.5% bond with four years remaining to maturity, that is, callable in one year at $99. Table 1 shows two values at each node. The first value is calculated considering the bond as an option-free bond and the second value is based on whether the issue will be called or not. We can clearly see how the cash flows will be effected if the issuer exercises the option to call.
Table 1: Valuing a Callable Bond
Interest rate caps as well as collars are available on the over the counter (OTC) market or may be devised using market based interest rate options. They may be utilize to hedge cu
The Central Bank is an authority responsible for monetary policy of its country. It regulates money supply and credit, issues currency, and manages exchange rate.
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