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I have a HKD callable bond maturing in 2022. the call schedule is bermudan and the next call date is 10/17/16 and redemption price is 100 (the call date is 10/17 every year till maturity). Initially it was priced to next call date using a comparable that was maturing around previous call date 10/17/15. The yield was around 1.1% based on comparables. If I look at the history, a year prior to now it started at a price of 104 and slowly converged to call price and now it again jumps back to 104.

My question is - is this correct? i.e. is pricing to next call and jumps around call date justified? I don't have a comparable bond maturing in 2022, but do have a few maturing around the next call date.

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  • $\begingroup$ Does this bond have any coupon schedule, i.e. step-up? $\endgroup$ – Nicholas Jan 19 '16 at 9:39
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It's often true that a bond handled in some arbitrage-free model has pricing behavior like that. Usually, the situation is that the issuer has pretty good credit, so from a theoretical point of view they should (almost certainly) be calling the bond at the next call date. The arbitrage price captures that and so it bounces up once the company declines to call the bond, against theoretical expectations.

Of course, calling a bond away in practice carries many costs not captured in most models, such as investment bank fees for issuing a replacement bond, regulatory fees and employee time, etc. etc. This is what is driving the company's decision.

Sometime you will see arbitrage models where traders can enter their guesses at call probabilities, or sometimes estimated call penalties, to compensate for the phenomenon.

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  • $\begingroup$ Ok, thanks for your response. It does have good credit (rated AA-), but I'm not sure why you'd say "they should (almost certainly) be calling the bond at the next call date" $\endgroup$ – access_nash Oct 20 '15 at 3:05
  • $\begingroup$ I am not referring to this particular bond, but rather to the fact that when these cases pop up it is usually because the company is a sufficiently good credit that they could cal the outstanding bond away and issue a new one in its place at a somewhat lower interest rate, thereby saving themselves some money. $\endgroup$ – Brian B Oct 20 '15 at 12:40
  • $\begingroup$ It definitely depends on the bond. Often they bonds will have a rate step up after a certain length of time, and it is assumed that the bind market will improve, such that they can get a more competitively priced bond else where. It is more complex for cocos where it is stipulated that (as t least to still count as at1) there can be no incentive for early exercise in the terms. $\endgroup$ – will Jun 17 '16 at 6:45

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