Introduction to call_and_put_options

Jun 28th, 2015
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An Embedded option is a component of a financial bond or other security, and usually provides the bondholder or the issuer the right to take some action against the other party. There are several types of options that can be embedded into a bond. Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, and exchangeable bond. A bond may have several options embedded if they are not mutually exclusive.

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What is an embedded option in a bond? List the types of option that can be embedded in a bond and discuss the impact of the embedded option on the value of a bond.Answer: An Embedded option is a component of a financial bond or other security, and usually provides the bondholder or the issuer the right to take some action against the other party. There are several types of options that can be embedded into a bond. Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, and exchangeable bond. A bond may have several options embedded if they are not mutually exclusive.Bonds with Embedded Options: Many bonds have embedded option features, like-Callable Bonds: Give issuer right to redeem the issue call price (par).Callable Bond = Straight Bond -Call OptionHigher yield due to call option premium receivedAs yields decline, value of call option increases, hence price compressionPricing of callable bondsPrice straight (i.e. non-callable) bondPrice call optionInterest rate option modelPrice (CB) = Price (NCB)-Price (CO)Putable Bond Yield sensitivityPrice compressionOption-adjusted convexity & durationYield to call: Calculate yield of bond assuming its expected cash flows are coupon payments to the first call date plus call price.Yield to worst: Calculate yield to call for all call dates and pick the lowestYield spreadStatic spreadOption adjusted spreadMonte-Carlo techniquesThe

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