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Callable Bond

  • Updated

Description

The callable bond should be used to model any type of public or privately traded bond from any source (government, municipal, corporate or otherwise) that contains a call option from the issuer.

Cash Flows & Timing

All cash flows on the callable bond occur at the beginning of each projection month. Cash flows occur in the following order.  Cash flows higher up the order may impact the amount of cash flows lower down.

  1. Call option exercised and call price paid
  2. Defaults
  3. Default Recoveries
  4. Coupon Payments
  5. Principal Payments

Model Point File

The following fields are included on the default Slope Library model point file definition for Callable Bonds.

Asset ID – A string field that is used for identification purposes only. This could be an ID from your asset administration system, the CUSIP, or any other identifier for the model point. This field is not used by any of the variables on the product and is for informational purposes only. It can be safely removed from the model point file definition if not needed.

AVR Line Number – The line number this bond should appear in on the Asset Valuation Reserve. This value is used to lookup the appropriate factors for AVR calculation as well as the RBC C-1 Other factor to apply for Risked Based Capital.

Call Period in Months – An integer value specifying the number of months, starting from the first call date, that the option is callable. For example, entering 24 in this field means that the option will remain callable for 2 years starting from the first call date.  A value that is greater than or equal to the maturity date, or results in a period of time that will extend past the maturity date will be automatically shortened so that the option is callable until the last month before maturity.

Coupon Payments Per Year – The number of coupon payments made each year. This determines the frequency and amount of the periodic coupon payments. The formulas in this product expects this value to be evenly divisible into 12 in order to properly calculate the payment months (i.e. 1, 2, 4, 6, or 12).

Coupon Rate – The coupon rate of the bond that is used to determine the periodic bond payments. This rate should be entered as a bond-equivalent rate (not annual effective) to ensure the proper bond payments are calculated.

Currency – A string value specifying the currency the bond is denominated in. This value is used to look up rates from the economic scenario file for market value calculations as well as to set coupon rates on new business model points during the asset purchase process. The value specified here must match on the currencies specified on the economic scenario file definition.

Initial Book Value – The book value of the bond as of the projection start date.

Initial Market Value – The market value of the bond as of the projection start date.

Initial Par Value – The par value of the bond as of the projection start date.

Issue Date – The original issue date of the bond. This is used in conjunction with the Term in Months to determine the maturity date of the bond. It is also used to determine when coupon payments occur. This should be the original issue date of the bond, which may not necessarily be the date you purchased it.

Months Until First Call – The number of months after the issue date when the bond is first callable. For example, a value of 60 in this field would mean that the first time the bond can be called is 5 years after issue. This value should be greater than 0 and less than the Term in Months.

NAIC SVO Rating – The bond rating from the NAIC Securities Valuation Office (SVO). This should be a value of 1-6 on callable bonds. This value is used to determine accounting treatment for statutory reporting.

Rating – The rating agency rating of the bond.  This value is used to determine the default rates experienced.  The default model expects this to be a Moody’s rating since the default lookup table is based on the Moody’s annual default study.

Spread – The credit spread over risk-free rates.  This spread is expected to include the expected future risk of default inherent in the bond price. This value is used to calculation market values of the bond as well as when setting the coupon rate on new business model points.

Term in Months – The number of months from the original issue date of the bond to the maturity date. Ex. a 5 year bond would have a value of 60.

Product Inputs

This section describes inputs that control how the product works that are not included on the model point file.  If these inputs need to vary by model point, then you should modify the formulas to pull the data from an appropriate source.

Call Frequency – The call frequency is only used when Call Type is equal to a value of 1.  The call frequency specifies the number of months between which the call option may be exercised. For example, a call frequency of 24 would indicate that the bond call option can only be exercised every 2 years starting from the first call date. A value of 0 in the Call Frequency means that the bond is only callable on the initial call date and never again thereafter. By default, this variable is set to a value of 12 (annual call option).

Call Premium – The call premium species of par value added to the price paid when the call option is exercised. For example, a call premium of 0.1 (10%) would mean that 110% of the par value is paid when the option is called. By default, this value is 0.

Call Tolerance – The call tolerance modifies the market value tolerance at which the option is called. By default, this value is set to 0 which means that the option gets called when the market value of calling the bond is less than the market value of cash flows to maturity. This input can change that tolerance by setting an increase/decrease % for this market value check.

Call Type – The call type specifies in more detail how the call option may be exercised within the call period. The following options are available.

  1. Anytime (Default) – The bond is callable at any time on or after the call date specified on the model point file. However, for simplicity, the model assumes that calls only occur on coupon payment dates. However, calls are assumed to occur before any coupon is paid out on those dates.
  2. Specific Intervals – The bond is only callable at specific intervals, starting from the initial call date, during the call period. When this option is selected, the variable Call Frequency is also used to specify the frequency at which the bond may be called.

Coupon Rate – The coupon rate on the bond. This value is read from the model point file Coupon Rate for all inforce model points. On new business model points, the coupon rate is determined by looking up the yield curve rate from the scenario file that corresponds to the bond term and adding the Spread from the model point file to that value.

Default Rate – The default rate is the annual effective rate of defaults. This product is set up to read the default rates from a table which is based on the Moody’s default study. It uses the Rating from the model point file, and the number of years since issue to look up a default rate.

Default Recovery Rate –  This specifies a percentage of the current market value of assets that default that will be recovered as cash. By default, this value is set as 0.

GAAP Classification – An integer value that indicates how the asset is reported on the GAAP Balance sheet. The following 3 options are available.

  1. Available For Sale (AFS)
  2. Trading
  3. Held to Maturity (HTM)

AFS and Trading assets are held at Market (Fair) Value. Held to Maturity assets are reported at amortized cost. By default the product is set to classify all assets as Available For Sale (1).