Callable Bond

ORE defines the product as follows:

A callable bond is a bond with issuer call and / or investor put rights. Typically, the call style is American while the put is Bermudan, but we support any combination of styles.

Source: ORE User Guide, Products catalogue, callablebond.tex.

A callable bond carries extra rights on top of the vanilla bond. The issuer can call the bond back at set prices on set dates. The investor can put it back to the issuer. The rights make the bond cheaper for the issuer and compensate the investor with a higher coupon.

The CallableBondData block names the bond and its quantity. SecurityId is typically the ISIN with the ISIN: prefix. BondNotional is the notional in the currency of the bond. The optional CreditRisk flag decides whether credit risk shows on the product. The bond terms of the trade are set up in reference data. The reference datum carries the BondData with the vanilla part of the bond, plus the optional CallData and PutData with the call and put terms. Without them there are no calls or puts. Styles holds the exercise styles, American or Bermudan. Bermudan also defines European exercises, namely as a Bermudan exercise with a single exercise date. ScheduleData holds a schedule of exercise dates for Bermudan exercises, or start and end dates for American exercises. Prices holds exercise prices in relative terms: a price of 1.02 means the amount paid on exercise is 1.02 times the current notional of the bond, plus accrued interest when the price type is clean. PriceType gives the flavour of the exercise prices, Clean or Dirty. IncludeAccrual decides whether accruals have to be paid on exercise, independently of the quoting style. Lists in the sub-nodes can be explicit lists or use the startDate attribute. An explicit value list can be shorter than the list of dates; the last value then applies to the remaining dates.

The callable bond splits into a vanilla bond and an embedded option position. The issuer call is a short option from the investor's view; the investor put is a long option. The exercise prices are quoted in relative terms and converted by the current notional. The value is the vanilla bond value adjusted for the call and put rights, with American and Bermudan exercise valued accordingly.

• The yield curve, which prices the vanilla bond and the embedded options.
• The credit of the issuer.
• The volatility of the yield curve; it raises the value of the rights.
• The exercise prices and the call and put schedules.

The bond is a vanilla bond plus optionality, so rates, credit and volatility all move its value. The issuer credit affects both the bond floor and the probability of the call.

The call and put rights run on their schedules. An American call can be exercised at any time in its window. Bermudan calls and puts can be exercised on their dates. As the bond approaches a call date, the issuer compares the call price with the market value. After the call periods pass, the bond ages as a vanilla bond to maturity.

Issuers sell callable bonds to lower their funding cost. Investors buy them for the higher coupon and the put protection. The structure is common in corporate and agency markets. In ORE Studio a customer books callable bonds to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a callable bond trade whose terms are set up in reference data:

<Trade id="CallableBond">
  <TradeType>CallableBond</TradeType>
  <Envelope>...</Envelope>
  <CallableBondData>
    <BondData>
      <SecurityId>ISIN:XS0123456789</SecurityId>
      <BondNotional>1000000.00</BondNotional>
    </BondData>
  </CallableBondData>
</Trade>

Source: ORE User Guide, Products catalogue, callablebond.tex, listing Callable bond set up using reference data. The source describes a Bermudan issuer call on three dates at a clean price of 100, 100, 102, with accruals paid on exercise, in its CallData example; the corresponding Price values are 1.00, 1.00 and 1.02.