Are embedded calls valuable? Evidence from agency bonds

King, Tao‐Hsien Dolly

doi:10.1016/j.jbankfin.2006.02.001

“…The report also lists all individual new issues of new perpetual securities by these banks during 2004/2005 and all of them have a deferred issuer's call option, typically exercisable 10 years from date of issue. King (2007) studies empirically the implicit value of embedded options in various U.S. agency bonds, their levels and relationship to maturity and interest rates. He finds that embedded call options in bonds issued by Federal Home Loan Mortgage Corporation on average represents 3.9 % of the bond values in the call protection period of up to 10 years.…”

Section: Outstanding Tier Uppermentioning

confidence: 99%

Callable risky perpetual debt with protection period

Mjøs

¹

,

Persson

²

2010

European Journal of Operational Research

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Abstract. Issuances in the USD 260 Bn global market of perpetual risky debt are often motivated by capital requirements for financial institutions. We analyze callable risky perpetual debt emphasizing an initial protection ('grace') period before the debt may be called. The total market value of debt including the call option is expressed as a portfolio of perpetual debt and barrier options with a time dependent barrier. We also analyze how an issuer's optimal bankruptcy decision is affected by the existence of the call option by using closed-form approximations. The model quantifies the increased coupon and the decreased initial bankruptcy level caused by the embedded option. Examples indicate that our closed form model produces reasonably precise coupon rates compared to numerical solutions. The credit-spread produced by our model is in a realistic order of magnitude compared to market data.

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Lessons from the collapse in hybrid bank capital securities

Yu

¹

,

Luu²

2012

IJMP

2

0

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This paper addresses the lessons that can be learned from the rise and fall of the market for hybrid bank capital securities during this decade's credit boom and bust. It is uncertain whether bank capital securities are going to survive as an asset class after the dramatic collapse in prices and the erosion of confidence among market participants. We examine the potential mis-pricing of the additional risks inherent in subordinated bank debt versus senior securities prior to the crisis. Using a cross-section of European banks, we ask whether there is a relationship between the issuance of hybrid bank capital securities and solvency risk, which became manifest in government bail-outs and the nationalisation of financial institutions. Finally, we argue that it could be beneficial to the stability of the financial sector if bank executives' compensation comprised a significant portion of subordinated debt.

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Callable Risky Perpetual Debt with Protection Period

Mjøs

¹

,

Persson

²

2005

SSRN Journal

0

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Abstract. Issuances in the USD 260 Bn global market of perpetual risky debt are often motivated by capital requirements for financial institutions. We analyze callable risky perpetual debt emphasizing an initial protection ('grace') period before the debt may be called. The total market value of debt including the call option is expressed as a portfolio of perpetual debt and barrier options with a time dependent barrier. We also analyze how an issuer's optimal bankruptcy decision is affected by the existence of the call option by using closed-form approximations. The model quantifies the increased coupon and the decreased initial bankruptcy level caused by the embedded option. Examples indicate that our closed form model produces reasonably precise coupon rates compared to numerical solutions. The credit-spread produced by our model is in a realistic order of magnitude compared to market data.

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Are embedded calls valuable? Evidence from agency bonds

Cited by 4 publications

References 25 publications

Callable risky perpetual debt with protection period

Callable risky perpetual debt with protection period

Lessons from the collapse in hybrid bank capital securities

Callable Risky Perpetual Debt with Protection Period

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