Question

At one point, certain U.S. Treasury bonds were callable. Consider the prices in the following three Treasury issues as of May 15, 2017:

05/15/2020		6.10				108.46875		108.53125		−	.31250		3.100
05/15/2020		7.15				109.00000		109.06250		−	.09375		3.920
05/15/2020		8.00				114.06250		114.25000		−	.46875		3.000

The bond in the middle is callable in February 2018. What is the implied value of the call feature? Assume a par value of $1,000. (Hint: Is there a way to combine the two noncallable issues to create an issue that has the same coupon as the callable bond?) (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

­SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

v * 5 13:54 ENG 16-03-2000 24 X FF1 V X FE fx FG FE FH FL FJ FK FLEMEN FO FPFO FR FS ET A NON CALLABLE BOND CALLABLE BOND NON CALLABLE BOND C3 WE HAVE TO MAKE AN EQUATION WHICH MAKES VALUE OF CALLABLE BOND EQUAL TO THE WEIGHTED AVERAGE OF NON-CALLABLE BONDS SUPPOSE "X"% IS INVESTED IN C1 AND "(1-x)" % IN C3 C2 = 7.15 = 0.85 = X = 1-X = C1(X) + C3(1-X) 6.10(X) + 8.00 (1-x) 6.10(X) +8 -8 (X) 2.10(X) 0.404762 0.5952381 SO APPROXIMATELY 40% TO BE INVESTED IN C1 AND 60% IN C3 P2 = P2 = P2 = P2 = (X) (P1) + (1-x) (P2) (0.404762)(108.53125) + (0.595238)(114.25000) 111.935268 111.94 ... BANKING NOTE Sheet2 51 53 CLEAN PRICE $10 BIDDING, UNDERWRITING EUAC AW LIFE LP, IP, MRP, INFLATION WARRANT refund 54 55 ... :

v u * 5 ENG 13:54 16-03-2000 24 FF47 FE FE FG FH FL FJ FK FLEM EN FO FP FQ FR FS FT CALL VALUE = CALL VALUE = CALL VALUE = ANSWER CALL VALUE = IMPLIED VALUE - ACTUAL VALUE 111.935268 - 109.0625 2.872768 2.87 46 ... BANKING NOTE Sheet2 S1 53 CLEAN PRICE 510 BIDDING, UNDERWRITING EUAC AW LIFE LP, IP, MRP, INFLATION WARRANT refund 54 55 ... :