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Fixed Income Securities, 4th Edition
book

Fixed Income Securities, 4th Edition

by Bruce Tuckman, Angel Serrat
September 2022
Beginner content levelBeginner
560 pages
17h 36m
English
Wiley
Content preview from Fixed Income Securities, 4th Edition

CHAPTER 16Fixed Income Options

This chapter describes some of the more common fixed income options, namely: callable bonds, which have embedded options; Euribor futures options, which are futures‐style options; bond futures options, which are equity‐style options; caps and floors; and swaptions. The reader is assumed to have some familiarity with the basics of options and options pricing. Also, with the transition to LIBOR replacements still in process at the time of this writing, caps and floors and swaptions are presented in terms of LIBOR.

While fixed income options are sometimes priced using term structure models, along the lines of Chapters 7 through 9, this chapter focuses on pricing with variations of the Black‐Scholes‐Merton (BSM) option pricing model. This simpler approach is often used by practitioners when the objective is not to determine which options among many are relatively cheap or rich, but rather to interpolate the prices of some options from the prices of similar, but more liquid options, and to calculate usefully accurate deltas or hedge ratios. An extensive appendix justifies the use of BSM in each case with mathematically simplified versions of modern asset pricing techniques.

16.1 EMBEDDED BOND CALL OPTIONS

There is not much of a market for stand‐alone options on bonds, but many corporate bonds include call provisions that give the issuer the right to call or buy back its bonds at some fixed schedule of prices. These provisions are called embedded ...

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