In a bear bond market interest rates are increasing causing bond values to decrease thus the probability of an early call decreases. Callable bonds are issued with a higher coupon rate as compared to noncallable bonds to compensate the purchaser for the probability of the bond being called. In a rising interest rate environment callable bonds will not fall in price as much as a comparable option free bond due to the negative convexity of the callable bond in the callable region of the bond. Thus, if portfolio managers expect interest rates to increase, they should buy callable structures instead of option-free bonds in order to capture the higher return of the callable bond since it will not fall in value as much as the non-callable bond. |
