From the course: Applied Fixed Income

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Binomial interest rate tree

Binomial interest rate tree

From the course: Applied Fixed Income

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Binomial interest rate tree

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- [Instructor] One way to visualize a callable bond like our 2 1/4 non-call one year berm is to look at a payout tree. I have a timeline on this slide with all the dates from issuance, July 2020 to maturity, October 2022, with all the quarterly call dates in between, starting with the first call date a year out at July 2021, Assuming that the bond was originally issued at 0.32%, the decision at each of those Bermudan call dates is whether or not the funding rate for Freddie Mac to replace this callable, either in bullet format, a new callable, or even in agency discount note, a money market instrument is higher or lower than the 0.32%. Also, let's assume at each call date, if rates are lower than 0.32, Freddie's underlying assets that they own get prepaid and they no longer need the callable bonds, so they would choose to call it away. If rates are higher than 0.32, Freddie Mac would be happy to continue paying interest on the callable and wait until the next call date. I've…

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