Need help in understanding example 8 (1)
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Explanation for Example 8 (1)
Here, company has issued callable bond which can be called in 3 years or will then become non- callable until maturity.
Now, company wants to effectively defease this liability from the books but it can’t buy these bonds with the cash in hand it has as the bonds are deemed expensive right now.
To defease this liability from the books, it looks out for similar callable bonds in the market but it can’t find any. So, its CFO has arranged a similar non-callable corporate bond and will establish a swaption to mimic the callable feature of the original bond.
So, hume basically woh swaption choose krna hai jisse callable bond ka feature ban jaye non -callable bond milake ..or C- ho jaye as non-callable bond mein toh interest rate girne se paisa ayega pura …but hume callable feature chaiye 3 years mein …toh uske liye C- krna hoga
C- will eventually be done if we sell a receive swaption i.e. sell a receive fixed pay floating swap.
Why are we not choosing the fourth option i.e writing the payer swaption?