High coupon bonds

Rule 5 For high coupon bonds with a maturity date greater than one year, the percentage change in a price will be smaller than for low coupon bonds with the same maturity. 

As with any commodity, supply and demand also play important roles in determining bond prices, and therefore their yields. A shortage of issues at a particular point in the curve— the result, perhaps, of an effort to reduce public-sector debt—depresses yields for that maturity. On the other hand, when interest rates decline— ahead of or during a recession, say—and new bonds are issued with increasingly lower coupons, the stock of outdated high-coupon bonds increases and can end up trading at a higher yield. 

Equation 17.3 expresses the yield spread between a high-coupon bond and a par bond as a linear function of the spread between the first bond s coupon and the par bond s yield and coupon. In reality, this relationship may not be purely linear. The yield spread between the two bonds, for instance, may widen more slowly when the gap between the coupons is very large. Equation 17.3 thus approximates the effect of a high coupon on yield more accurately for bonds trading close to par. 

The zero-correlation (y = ) price of a coupon bond option with a moneyness 1.14 is about 1.7 times as high as the corresponding option price obtained by a perfect correlation stnjcture (y = 0). The corresponding zero-coupon bond option price is about 60 times as high as its perfect correlation equivalent. 

This model incorporates mean reversion, which is not an imrealistic feature. Mean reversion is the process that describes that when the short-rate r is high, it will tend to be pulled back towards the long-term average level when the rate is low, it will have an upward drift towards the average level. In Vasicek s model, the short-rate is pulled to a mean level 6 at a rate of a. The mean reversion is governed by the stochastic term odW which is normally distributed. Using Equation (3.24), Vasicek shows that the price at time t of a zero-coupon bond of maturity T is given by ... 

The reason for the price/yield relationship for a callable bond is as follows. When the prevailing market yield for comparable bonds is higher than the coupon rate on the callable bond, it is unlikely that the issuer will call the issue. For example, if the coupon rate on a bond is 7% and the prevailing market yield on comparable bonds is 12%, it is highly unlikely that the issuer will call a 7% coupon bond so that it can issue a 12% coupon bond. Since the bond is unlikely to be called, the callable bond will have a similar price/yield relationship as an otherwise comparable option-free bond. Consequently, the callable bond is going to be valued as if it is an option-free bond. However, since there is still... 

To gain exposure to sectors where, for various reasons, they do not wish to make actual purchases, investors can use a variation on a TR swap called an index swap, in which one of the counterparties pays a total return tied to an external reference index and the other pays a LIBOR-linked coupon or the total return of another index. Indexes used include those for government bonds, high-yield bonds, and technology stocks. Investors who believe that the bank loan market will outperform the mortgt e-backed bond sector, for instance, might enter into an index swap in which they pay the total return of the mortgage index and receive the total return of the bank-loan index. 

As already discussed, lOs, which receive the interest payments of the underlying collateral, and POs, which receive principal payments, exhibit different price behavior from pass-throughs and from each other. Figure 14.5 (page 263) showed that when interest rates are very high and prepayments, accordingly, unlikely, POs act as if repayable at par on maturity, like zero-coupon bonds. When interest rates decline and prepayments... 

Because it is affected by current demand, the yield of a particular zero-coupon bond at any time may differ from the equivalent-maturity spot yield. When investors value an individual zero-coupon bond less highly as a stripped security than as part of a coupon bond s theoretical package of zero-coupon cash flows, the strip s yield will be above the spot rate for the same maturity. The opposite happens when investors prefer to hold the zero-coupon security. 

The figure shows that, when the curve is inverted, investors can pick up yield while shortening duration. This might seem an anomalous situation, but in fact, liquidity issues aside, the market generally disfavors bonds with high coupons, so these usually trade cheap to the curve. 

Because it is affected by current demand, the yield of a particular zero-coupon bond at any time may differ from the equivalent-maturity spot yield. When investors value an individual zero-coupon bond less highly as... 

A first kind of these insurance products are called "catastrophe bonds" and consist in securitizing environmental risks in bonds, which could be sold to high-yield investors. The catastrophe bonds are able to transfer risk to investors that receive coupons that are normally a reference rate plus an appropriate risk premium. By these products, insurance companies limit risk exposure transferring natural catastrophe risk into the capital markets. In this way, with the involvement of the financial markets, their global size offers enormous potential for insurers to diversify risks. 

As yields in the market decline, the concern is that the issuer will call the bond. The issuer won t necessarily exercise the call option as soon as the market yield drops below the coupon rate. Yet, the value of the embedded call option increases as yields approach the coupon rate from higher yield levels. For example, if the coupon rate on a bond is 7% and the market yield declines to 7.5%, the issuer will most likely not call the issue. However, market yields are at a level at which the investor is concerned that the issue may eventually be called if market yields decline further. Cast in terms of the value of the embedded call option, that option becomes more valuable to the issuer and therefore it reduces the price relative to an otherwise comparable option-free bond. In Exhibit 4.16, the value of the embedded call option at a given yield can be measured by the difference between the price of an option-free bond (the price shown on the curve a-a ) and the price on the curve a-b. Notice that at low yield levels (below y on the horizontal axis), the value of the embedded call option is high. 

The price volatility characteristic of a callable bond is important to understand. The characteristic of a callable bond—that its price appreciation is less than its price decline when rates change by a large number of basis points—is referred to as negative convexity. But notice from Exhibit 4.16 that callable bonds do not exhibit this characteristic at every yield level. When yields are high (relative to the issue s coupon... 

Unlike tests on monolithic test coupons involving stress states that are relatively uniform within the test section, stresses present within adhesive Joints are, with few exceptions, highly complex and non-uniform. When interpreting the results from tests on adhesive bonds, one must recognize that adhesive bonds are actually structures in the sense that they involve inherent complexities in stress distributions. Understanding the stresses within test specimens and bonded components requires detailed analysis, the sophistication of which depends on the complexities of the Joint and the desired accuracy of the solution. A failure to recognize these complexities can lead to erroneous design procedures and incorrect interpretation of Joint failures. 

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