Early Retirement of Zero-Coupon Bond

[Liming]

Dear David,

Appreciate your helpful insight on the early retirement of zero-coupon bond. I'm wondering whether zero-coupon bond shall NEVER be possible to be called before its maturity but it can be put before its maturity day. And if this is correct, do we, in reality, sometimes see zero-coupon bonds issued with embedded put feature and never see zero-coupon bond with embedded call feature?
Thanks a lot!

Cheers
Liming

11/11/09

 

[David Harper CFA FRM]

Hi Liming,

I can't speak wisely to current practices vis a vis call/put provisions (the typical view is speculative grade bonds are more prone to call provisions)

From an FRM perspective, however, we treat call and put options as embedded options (Fabozzi) that are "optional" features of the bond that are "independent of" zero coupon/coupon status; i.e., bond is zero coupon or coupon

...then regardless of zero/not status, it's a separate question of whether the bond has an embedded call/put provision ... our most obvious encounter with the embedded option is the MBS where prepayment makes the bonds equivalent to callable bonds (i.e., underlying homeowners can refinance) and so introduces neg convexity at low yields

David