We want to design a compensated prepayment liability index to define an amount a bond buyer would need to receive in a redemption prior to the nominal maturity of a bond.
Ideally we'd like to deliver a floating rate BBB return (with the rate reset each year) through redemption. Said another way, at redemption the bond buyer will receive their entire principal + a return over the bond's rating through the length of time we have the bond buyer's money. OR another way, think of a something like a high quality corporate bond that one can redeem if you deliver a higher (BBB) return (with the floating feature to hedge rate increases).
The bond's coupons float at 1 year Treasuries + something subject to CAPS and FLOORS. The compensated prepayment liability index does not need to align with how we calculate coupons, but it might make for a simpler description of the instrument.
If I could find a floating rate BBB yield curve (going out to perhaps 10 years) that would work or at least serve as a starting point, but I haven't found a ready example of one. Even a fixed rate BBB yield curve would help, then I could make some kind of adjustment for it floating. If anyone can suggest sources or Bloomberg pages I can call up for either these, that would help a lot.
To model a floating rate BBB return we've looked at resetting the rate each year to 1 year Treasuries + 200 bp and this might make a fair compensated prepayment if the company issuing the bond can redeem it in under 5 years.
It just doesn't look rich enough to me over longer timeframes, but my colleagues and I are divided on this.
I'd like to develop a simple model, from which to derive a floating rate BBB yield curve from something more basic and readily available, like the US Treasury yield curve or a Corporate Bond yield curve.
Clearly, it will need factors to address the spread between BBB and treasuries or corporates and something to fairly price floating.
It might also need a kind of altered float, perhaps something like the following redemption schedule:
- 1 year: 1 year treasuries + n bps
- 2 year: 2 year treasuries + n bps
- 3 year: ...
Any suggestions of how to go about this, think about it, or sources to inform it much appreciated.