Wednesday, 7 December 2011

Applying Level I - Callable Bonds

A callable bond is one with an embedded option to be called by the issuer when its price rise with fall in the interest rates. It is noticeable that the price of the callable bond is calculated by subtracting option cost from an equivalent non-callable bond. In a callable bond the bond holder (lender) is seller/writer of the call option whereas the bond issuer (borrower) is holder/buyer of the call option. For this reason the bond holder pays less, equal to the option premium which he indirectly receives by paying less. The purpose of this post is to connect what we had studied in Level I with real world examples. As the candidates who appeared in LI exam, this past Sunday, would be free and their knowledge would be fresh. The application of their knowledge in terms of real life examples will provide them with an opportunity to see the importance and relevance of what they know!

The link provided at the bottom is a news pic of November 2, 2011 taken from Bloomberg in which Rabobank Nederland, the Dutch lender that has the highest ratings of any private European bank, priced the first capital notes that meet new regulations, showing the extra costs faced by lenders.

Its $2 billion of undated Tier 1 bonds, callable after 5 1/2 years, were priced to yield 8.4 percent. The notes comply with so-called Basel III rules that mean they can be written down if Rabobank’s equity capital ratio sinks, or may sink, below 8 percent, according to the terms of the deal.

The detailed news can be found on:

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